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The Treasury Inspector General for Tax Administration (TIGTA) has released the results of its audit of the IRS Tax-Exempt Compliance Unit (TECU), which was evaluated on the effectiveness and efficiency of its processes and procedures. TIGTA concluded that TECU experienced increased delays, fewer closed cases, and an increase in employee errors in fiscal year 2023 when compared to the 2020 fiscal year; TIGTA concluded TECU could operate more efficiently without imposing additional burden to taxpayers.

Background

In November 2020, the IRS initiated the Lean Six Sigma (LSS) Compliance Check project

(LSS project), which made 11 recommendations for improving the structure and processes of TECU, a unit of IRS Tax-Exempt and Government Entities (TE/GE). As a result, TECU is now one unit comprised of six work groups that follow the same compliance check process. Each group is assigned one or more workstreams developed by TE/GE's Compliance, Planning, and Classification (CP&C) function.

Most of the work conducted by TECU relates to compliance checks, which are reviews (not examinations) to determine if tax-exempt organizations comply with their federal tax return filing, reporting and payment obligations. For instance, three recent TECU workstreams are (i) obtaining delinquent Forms 4720 for excessive compensation excise tax under IRC Section 4960, (ii) addressing noncompliance with IRC Section 501(r) based on information found on hospitals' web sites and Forms 990, and (iii) obtaining delinquent Forms 940 and verifying whether federal unemployment tax has been accurately reported. The IRS intends for these compliance checks to educate and reach more taxpayers at a lower cost than traditional IRS examinations.

TIGTA completed the TECU audit to assess the effectiveness of TECU's efforts to improve its overall tax administration.

Decreased efficiency

TIGTA reported that the TECU examiners spent nearly three times as many hours closing fewer than half as many cases during FY 2023 compared to FY 2020.

The report found that TECU examiners routinely expanded the scope of each compliance check through manual searches for delinquent returns — something that could be replaced by an automated workstream. Similarly, TIGTA found that TECU may contact a taxpayer multiple times if the taxpayer is assigned to multiple TECU workstreams, as no controls exist to prevent multiple TECU groups from requesting the same information.

The practice of researching a taxpayer's account for delinquent returns outside the relevant workstream has resulted in a labor-intensive process, TIGTA found. According to data provided by TE/GE management, from FY 2020 through FY 2023, the average hours spent on each case increased 281%, from 1.6 hours per case to 6.1 hours per case. In addition, TIGTA found that the number of compliance check cases worked by TECU decreased from 12,414 in FY 2020 to 7,953 in FY 2023, with closed cases dropping 57% from 10,115 to 4,363 over the same period.

According to TE/GE management, the temporary reassignment of 32 examiners, along with the hiring of 29 new employees and the new compliance check and workstream procedures, contributed to the increased hours per case and decline in closed cases.

While the IRS agreed with the report's recommendation to develop a workstream for taxpayers that might have multiple delinquencies, it disagreed with a recommendation to eliminate the requirement that TECU examiners research beyond the assigned workstream, arguing that checking for additional delinquent returns ultimately reduces taxpayer burden and administrative costs.

Additional findings and recommendations

Upon review of a sampling of 68 of the closed 3,480 TECU compliance check cases, TIGTA identified seven instances where delinquent returns were identified and collected but not properly posted to the taxpayers' IRS accounts, due to employee error. TIGTA recommended that TECU give taxpayers the option to electronically file delinquent returns — rather than mailing them to TECU — to reduce human error, make the process more efficient, and prevent further delays. The IRS agreed with this recommendation and will revise its initial letters issued to taxpayers to include the option to electronically submit delinquent filings rather than require them to mail the forms to TECU.

TIGTA also found inconsistencies in procedural guidance to TECU examiners on whether to look for delinquent returns in addition to focusing on assigned workstream issues (e.g., 4960 compensation excise tax, 501(r) compliance, employment tax reporting). The IRS agreed with TIGTA's recommendation to make this procedural guidance clear and more consistent.

During its review, TIGTA discovered TECU has not established quantifiable performance standards to evaluate its success. TECU has evaluated its performance based on the number of hours worked on each case, number of cases closed, total days from the start of an examination to its closure and change rates. TIGTA recommended that TECU standardize its measurement of performance using targets based on prior year patterns to help provide perspective on progress and improvements. The IRS did not agree with this finding and believes performance measures are in place that allow for the recommended evaluation and therefore did not adopt/implement this recommendation.

TECU referrals leading to examinations

TIGTA reported that TCU referred 2,132 cases to the CP&C during the FY 2020 through 2023 period for assignment to the TE/GE Examinations function. As of February 2024, however, TE/GE Examinations had worked only 5% (113) of those cases and closed 88 of them. Of those 88 closed cases, 51% were closed without requesting any changes by the taxpayer.

CP&C management explained that it did not assign most of these TECU referrals to the TE/GE Examination function because of the experience and location of the tax examiners, limited resources, and balancing Examination workplan priorities. TIGTA found that TECU and CP&C management have not established focused criteria for referring cases to the Examination functions, and that TECU examiners generally refer cases to examination when they receive only a partial taxpayer response, rather than because those cases meet examination referral criteria.

The IRS agreed with the report's recommendation that TE/GE should better align procedural guidelines for TECU examination referrals with CP&C criteria for assigning cases for examination.

Implications

The TIGTA audit highlights several areas where the IRS Tax-Exempt Compliance Unit (TECU) could improve its operations to better fulfill its mission of increasing taxpayer compliance. The IRS has agreed with and plans to implement most of TIGTA's recommended process improvements. Addressing the issues identified in the audit could lead to more efficient use of resources, improved taxpayer service, and enhanced compliance outcomes.

The IRS's response to the TIGTA report, indicating that it plans to take measures to improve its TECU procedures, shows both its commitment to increasing consistency and efficiency in its TECU procedures and to strengthening its customer service. With this corrective plan in place, exempt organizations should expect their compliance checks to be processed and resolved in a more timely and efficient manner.

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