Section 8—Financial Accountability


In order to regain the trust of Congress and the American people, the IRS must demonstrate that it is financially accountable. This will entail developing information systems and procedures to prepare accurate and auditable financial statements and to capture necessary operational and management data to make informed business decisions.


1. Financial Reporting

The IRS and GAO must work together to resolve the IRS financial reporting problems.

Both GAO and the IRS agree that the overriding financial management problem is that the IRS financial system was not designed for financial reporting purposes. The present system predates the financial reporting requirements. Until the system modernization is complete, the IRS will have a continuing problem "making do" with what it has. The size and complexity of the tax processing systems and the care needed to analyze the impact of major system changes have contributed to the slowness of this process. The IRS has set a priority of making technology improvements that will enable it to meet its financial reporting responsibilities, and should continue these efforts.

It is clear that when the audit requirement was first imposed, the IRS had major problems with financial reporting and its control systems. It also is clear that GAO has been instrumental in identifying those problems and has helped the IRS in devising solutions. This working relationship seems strained today. The IRS continues to seek an unqualified opinion on its financial statements. To achieve this goal, GAO and the IRS must continue to work together, proactively seeking methods to overcome the IRS remaining problems. This may mean more time for the auditors and the application of more resources, but it is the attitude and relationship that is necessary for IRS to succeed in this effort.


2. Financial Statements

To regain the trust of Congress and the American people, the IRS must obtain a clean financial audit.

As one of the pilot agencies under the Chief Financial Officer Act of 1990, the IRS was required to prepare financial statements beginning with fiscal year 1992. Prior to that time, the IRS and other federal agencies were not required to prepare auditable financial statements or to have financial audits. The GAO has been unable to express an opinion on the reliability of the IRS financial statements for any of the four fiscal years from 1992 through 1995. It is now completing its audit for fiscal year 1996.

The IRS has two sets of financial statements, administrative and custodial, and two separate financial processes to account for the funds. The administrative system deals with the appropriated funds for IRS operations (approximately $7.3 billion) and the related expenditures for operation of the IRS. The custodial system tracks the tax collection process and the distribution of the collected funds to the appropriate account, including the Treasury general fund, Social Security trust fund, and highway trust fund.


Administrative Financial Statements

Three major problems generally have been cited for GAO’s inability to express an opinion on the IRS administrative financial statements for fiscal years 1992 to 1995: (1) the IRS failure to reconcile its cash balances with Treasury, (2) a lack of receipt and acceptance documentation for certain nonpayroll payments to other federal agencies, and (3) accounting for accrued liabilities at year end. Concerning the Treasury reconciliation, the IRS believes the problem is solved for fiscal year 1996, and that it is now maintaining current reconciliation with Treasury balances. The GAO has indicated that it will not take exception to the cash balance in its report on the IRS fiscal year 1996 financial statements.

The lack of receipt and acceptance documentation from other federal agencies is difficult for the IRS to solve by itself. The problem involves the government’s Online Payment and Collection (OPAC) system. For the IRS, this primarily involves payments to the General Services Administration (GSA) for rent and to the Government Printing Office (GPO) for printing.

Under the interagency payment process using the OPAC system, an agency that provided goods or services to the IRS directly accesses a general (i.e., not appropriation specific) IRS account at Treasury, takes the money that the "providing" agency claims to be due, and sends a notice to the IRS through OPAC that the funds have been withdrawn from the IRS account. This is done irrespective of whether the withdrawing agency has provided the IRS Chief Financial Officer with sufficient documentation of the services provided so that subsequent approval of this payment can be sought within the IRS. The OPAC notice may or may not reference an interagency agreement or provide a contact point at the providing agency or the IRS that accounting can contact to seek the subsequent approval of payment. If the IRS does not believe it has sufficient information to verify an OPAC charge, it can "charge back" the agency (i.e., take the money back). However, the agency the IRS just "charged back" is free to do the same.

When OPAC bills do have sufficient documentation, it may take months for the IRS to record proper receipt and acceptance as the required line numbers often are in the thousands, as is the case with bills submitted by GPO for tax forms. Meanwhile, amounts have been charged to the IRS nonappropriation specific account in the Treasury general fund and cannot yet be posted correctly in the IRS accounting system until the OPAC bills are itemized in detail, by appropriation and with other accounting codes. The OPAC billing is in a suspense account and remains an issue for the IRS until resolved.

Even with timely receipt and acceptance for a specific OPAC bill, IRS also runs into problems when another agency, such as GPO, contracts with a commercial vendor to provide services for the IRS. For example, GPO contracts with third party vendors to print and mail tax packages directly to taxpayers. When the vendor completes this task, GPO "bills" the IRS. It in turn relies on GPO’s internal receipt and acceptance procedures, and an exception process (i.e., phone calls and complaints), to assure itself that the task was done and the forms printed and mailed. GAO has indicated that this may not be sufficient.

The OPAC issues are a problem for other federal agencies, and there is now a government wide working group addressing it. This working group should develop a receipt and acceptance procedure similar to that required for outside vendors. GAO takes the position that receipt and acceptance documentation must be in place to properly account for and ensure that the IRS has adequate control over its expenditures, and for GAO to audit these expenditures using professional auditing standards. Because either GAO or outside contractors are auditing and expressing an unqualified opinion on the financial statements of payment recipients, including GPO, opportunities should exist for collaboration to find the most effective and efficient solutions for the IRS.

A third problem involves accounts payable and accrued expenses. The IRS records encumbrances when goods or services are ordered. This is a normal governmental practice to track the status of appropriations. At year end, some of the encumbrances, which may be estimates, are included in IRS liabilities. Because the liability does not occur until the goods or services are delivered, IRS liabilities often are overstated. For fiscal year 1996, the IRS and GAO worked together to prepare and audit, respectively, a statistical sample of subsequent disbursements to estimate IRS accounts payable. As a result of this effort, GAO is not taking exception to the liabilities reported on the statement of financial position.


Custodial Financial Statements

Two significant factors have been cited for GAO’s inability to express an opinion on the custodial financial statements: (1) weaknesses in the revenue accounting system; and (2) reliability of IRS reported estimates of collectible accounts receivable. Both of these problems are difficult to resolve with the existing financial accounting system.

The basic problem with the revenue accounting system is that it has been difficult, if not impossible, to substantiate the revenue collected by matching the gross amounts collected with the individual transactions recorded in the IRS master files. The historic reason for this is that revenue posted to the Revenue Accounting Control System (RACS) comes from summary data not specifically identified with individual transactions. Income tax returns are grouped in "blocks" of up to 100 returns at the service centers, and revenue is posted in total by blocks in RACS. Financial statement revenue amounts reflect the amounts recorded in RACS. Although a record exists of the returns contained in each block, it is not well maintained nor is it easily accessible. For fiscal years 1995 and 1996, the IRS attempted to solve this problem by compiling financial statement revenue and refund amounts from the master files and reconciling the computed amounts to RACS and to Treasury schedules of receipts. This method provides detailed support to substantiate the financial information. The process was not completed in time for the fiscal year 1995 GAO audit and review; the fiscal year 1996 audit now is in progress.

Another problem with the revenue accounting system is the inability to verify the reported amounts for various types of taxes, particularly social security and excise taxes. The difficulty stems from the fact that taxpayer documentation submitted with payments does not separate the types of tax paid. For instance, federal tax deposits for payroll taxes include social security tax and income tax withheld without identifying the amount for each. Individual tax amounts are compiled from the quarterly returns filed, which represent assessments and not necessarily payments. The amount required to be transferred to the Social Security trust fund is based on the assessed amount, not the IRS collected amount, so the outcome will be unchanged by better reporting. Similarly, excise tax payments may include up to 100 different taxes without identifying what is being paid. IRS tests indicate that the difference between the amounts collected and the amounts assessed is insignificant, but it is developing programs to identify collected amounts of excise taxes, because the amounts required to be transferred to these trust funds are based on collected amounts.

The problem with the accounts receivable verification involves separating financial accounts receivable from compliance assessments. The IRS divides its inventory of tax receivable into three major categories: (1) financial receivables; (2) compliance assessments; and (3) financial write-offs. The only receivables included on the financial statements are the financial receivables which are then reduced by an allowance for doubtful accounts. Financial receivables consist of balances due when the IRS has demonstrated the existence of a receivable through information provided directly from the taxpayer, or through actions taken by the IRS that support or validate the IRS claim, such as securing the taxpayer’s agreement or a favorable court ruling. Compliance assessments consist of assessments primarily made for enforcement purposes. Actions still may be taken to collect these assessments, but because the taxpayer has not responded to validate the claim, or Appeals or the Tax Court has not yet ruled, there is not an established claim with the taxpayer. Financial write-offs are a separate category of financial receivables whose ultimate collection is unlikely. Due to the ten year statute of limitations, the IRS must maintain these accounts on the master files until the statute for collection expires.

All of the categories of receivables are commingled in the master files, but the IRS has attempted to segregate the categories by coding in the master file. For fiscal year 1995, GAO determined that errors in coding and errors in performing the statistical tests designed to test the accuracy of the coding made validity of the categorization questionable. For fiscal year 1996, GAO has indicated that the systemic process for segmenting the portfolio of receivables appears reasonable. It remains for the GAO to review supporting documentation for selected cases to verify the accuracy.


3. Operational Data

The fact that the IRS has made substantial progress toward obtaining an unqualified opinion on its financial statements does not mean that it has solved its financial management problems. The IRS has a poor track record of capturing accurate compliance, cost, and customer service data. While the Statistics of Income data is heralded as accurate and useful, and compliance research efforts appear to be helping the IRS target its resources more efficiently, the Commission found Congress and stakeholders skeptical of the IRS ability to measure and track much of the information necessary for its managers, as well as executive and legislative branch overseers, to make long-term strategic decisions and hold the agency accountable. When the IRS is unable to break down processing costs according to type of tax form, productivity gains cannot be measured. Measuring performance becomes very difficult if baseline data is lacking or unreliable.

As outlined in the budget discussion in Section 1 of this Report, over the next three years the Commission recommends improvements in financial management at the IRS. The agency must obtain a clean opinion on its financial audit of appropriated accounts and make significant progress in receiving a clean opinion on the custodial accounts (revenues); have independent verification that its compliance and taxpayer service statistics are accurate; and gather accurate taxpayer focused operational cost data that is verified as accurate by an independent organization.

The Commission recommends that an advisory committee be established consisting of individuals with expertise in governmental accounting and auditing from both the private sector and from government. This committee would advise the Board of Directors on the following issues:


· Areas of disagreement between the IRS and GAO;
· Monitoring the financial accounting aspects of the systems modernization;
· Considering the need for year round auditing so that problems are identified in time to be corrected; and
· Monitoring IRS plans for improving its internal financial management system.


The advisory committee will provide the necessary expertise to assist the Board in ensuring that the financial accountability problems of the IRS are resolved.



The eight sections of this Report represent a comprehensive review with recommendations for improving the IRS and the American tax system. Each recommendation aims to help create an IRS that recognizes its vital duty to represent the federal government in a fair, efficient, and taxpayer friendly manner. The IRS is in a unique position—twice as many people pay taxes as vote. Therefore, it is incumbent upon Congress and the President to ensure that the IRS does not view its mission as extracting money out of taxpayers, but rather as collecting the proper amount of taxes in the least intrusive, most helpful way possible. Implied in our analysis is the belief that most American citizens are willing to pay their fair share of taxes, and that the government should make it easier for them to do so.

As is embodied throughout this Report, the Commission believes that taxpayer service must become paramount at the IRS, and that the IRS should only initiate contact with a taxpayer if it is prepared to devote the resources necessary for a proper and timely resolution of the matter. In order to effect change at all levels of the agency, the IRS needs the appropriate accountability, continuity, and expertise in both congressional oversight and executive branch governance.

In short, all of our recommendations, taken as a total package, will make the IRS more accessible and responsive to the American people. The Commission believes that this comprehensive reform plan is necessary to restructure the IRS for the twenty-first century.