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Consequently, at the time tax payments are made, IRS is not provided information on the ultimate recipient of the taxes collected. Furthermore, the type of tax being collected is not distinguished early in the collection stream. This creates a massive reconciliation process involving billions of transactions and subsequent tax return filings.

For example, when an individual files a tax return, IRS initially accepts amounts reported as a legitimate record of a taxpayer's income and taxes withheld. For IRS' purposes, these amounts represent taxes paid because they cannot be readily verified to the taxes reported by an individual's employer as having been paid. At the end of each year, IRS receives information on individual taxpayers' earnings from the Social Security Administration. IRS compares the information from the Social Security Administration to the amounts reported by taxpayers with their tax returns. However, this matching process can take 2 and a half years or more to complete, making IRS' efforts to identify noncompliant taxpayers extremely slow and significantly hindering IRS' ability to collect amounts subsequently identified as owed from false or incorrectly reported amounts.

Consistent with this process, IRS' system is designed to identify only total receipts by type of return and not the entity which is to receive the funds collected, such as the General Fund at Treasury for employee income tax withholdings or the Social Security Trust Fund for FICA. Ideally, the system should contain summarized information on detailed taxpayer accounts, and such amounts should be readily and routinely reconciled to the detailed taxpayer records in IRS' master files.

Also, IRS has not yet established an adequate procedure to reconcile the revenue data that the system does capture with data recorded and reported by Treasury. Further, documentation describing what IRS' financial management system is programmed to . do is neither comprehensive nor up-to-date, which means that IRS does not yet have a complete picture of the financial system's operations--a prerequisite to fixing the problems.

Beginning with our audit of IRS' fiscal year 1992 financial statements, we have made recommendations to correct weaknesses involving IRS' revenue accounting system and processes. They include

-- addressing limitations in the information submitted to IRS

with tax payments by requiring that payments identify the type of taxes being collected,

implementing procedures to complete reconciliations of
revenue and refund amounts with amounts reported by the
Treasury, and

documenting IRS' financial management system to identify and correct the limitations and weaknesses that hamper its ability to substantiate the revenue and refund amounts reported on its financial statements.

Short-term Fixes to Revenue Accounting Problems The problem of identifying collections by type of tax results from inherent limitations in IRS' present financial system. To correct this problem in the short-term, IRS has developed a methodology that uses software programs IRS believes will capture from its revenue financial management system the detailed revenue and refund transactions that would support reported amounts in its future financial statements. In short, this approach is directed at developing reasonable estimates of taxes by type of tax collected by using the capabilities of IRS' present systems. .

To reconcile IRS' tax revenue data with Treasury's balances, IRS' plans call for the extracts from these software programs to be available in accordance with the following schedule.

Data for the first 6 months of fiscal year 1996 will be
available by October 1, 1996.

-- Data for the entire fiscal year will be available by January

15, 1997.

To provide an allocation of taxes between Social Security, income, and excise taxes, IRS plans call for the extracts from these software programs to be available in the following timeframes.

-

Allocations for the first three quarters of fiscal year 1996 are due by November 30, 1996.

An allocation for the final quarter of fiscal year 1996 is due by January 30, 1997.

Also, regarding the issue of reconciling accounting records with individual taxpayer accounts, IRS is trying to better understand the differences between its systems and Treasury's records. TO gain this understanding, IRS plans to soon complete documentation of its revenue financial management system. This is critical to (1) aid in identifying better interim solutions for reporting revenues and refunds and (2) provide better insights on the longer term system fixes needed to enable IRS to readily and reliably provide the underlying support for its reported revenue and refund amounts.

Fixing Revenue Accounting Problem Long-term IRS has not yet put in place the necessary procedures to routinely reconcile activity in its summary accounting records with that maintained in its detailed masterfile records or taxpayer accounts. This

problem is further exacerbated by IRS' financial management system, which was not designed to support financial statement presentation, and thus significantly hinders IRS' ability to identify the ultimate recipient of collected taxes.

Longer term system fixes are necessary to achieve more reliable reporting of these amounts. In this regard, as part of Tax Systems Modernization, IRS has designed the Electronic Federal Tax Payment System (EFTPS), to electronically receive deposits from businesses. EFTPS is planned to be operational by the end of 1996. If implemented as designed, EFTPS will have the capability of collecting actual receipt information for excise and social security taxes.

However, not all employers will be required to use EFTPS to make their federal tax deposit payments. According to IRS officials, approximately 20 percent of the employers that make federal tax deposit payments will have the option of remaining with the current system, which provides limited information. Therefore, even if employers that use EFTPS are required to provide additional information on social security and excise taxes, to the extent that some businesses will still make deposits using the current system, IRS will not have the complete information it needs to determine collections from excise and social security taxes.

In addition, IRS will have to make changes to meet criteria for determining revenue that are contained in federal accounting standards, which will be effective for fiscal year 1998. This will require IRS to account for the source and disposition of all taxes in a manner that enables accurate reporting of cash collections and accounts receivable and appropriate transfers of revenue to the various trust funds and the general fund. TO achieve this, IRS' accounting system will need to capture the flow of all revenue-related transactions from assessment to ultimate collection and disposition.

Also, IRS' revenue accounting system does not meet the government's standard general ledger or other financial management systems requirements. According to IRS, these requirements are not being met because the revenue accounting system was designed more than 10 years ago to post transactions to taxpayers' accounts. IRS is in the initial stages of developing a new revenue financial accounting system which is expected to meet the government's standard general ledger and other financial management systems requirements. However, the new system is not expected to be completed until after 1998.

TSM PROBLEMS IMPACT IRS
FINANCIAL INFORMATION

IRS' capability to develop and make automated systems changes is an area of continuing concern, as we have discussed in our reports and testimonies on IRS' Tax Systems Modernization (TSM). (See attachment I.) In March 1996, we testified before the Subcommittee on IRS' significant challenges in financial management and systems modernization, which are central to IRS' guardianship of federal revenues and ability to function efficiently in an increasingly technological environment.

In summary, IRS has initiated actions that begin to implement the dozens of recommendations we have previously made to correct management and technical problems in developing TSM. Many of these actions are still incomplete and do not yet respond fully to any of our recommendations. As a result, until IRS makes more progress in correcting its management and technical weaknesses, its ability to develop systems and make changes to correct financial management problems will be hampered.

IRS TOUCHES FINANCIAL REPORTING
ACROSS GOVERNMENT

The CFO Act, as expanded by the Government Management Reform Act of 1994, requires the 24 CFO Act agencies to prepare, and subject to audit, financial statements covering all accounts and associated activities of each office, bureau, and activity of the agency. This requirement begins with agencies' financial statement for fiscal year 1996. Audit reports are to be prepared by March 1 of 1997 and each year thereafter.

In addition to agencywide financial statements, the expanded CFO Act requires the Secretary of the Treasury to annually prepare consolidated financial statements depicting the Executive Branch's financial status. This requirement begins with financial statements for fiscal year 1997; GAO is to audit them by March 31 of each year, beginning in 1998.

IRS' financial information will provide significant input to the preparation and audit of both Treasury's agencywide and the governmentwide financial statements. For example:

-

With $1.4 trillion in tax revenue, IRS accounts for the vast majority of the government's total reported fiscal year 1995 revenue.

IRS' $113 billion in reported accounts receivables is over two-thirds, or about 68 percent, of the government's total fiscal year 1995 accounts receivables, which Treasury reported to be more than $166 billion.

44-755 - 97 - 3

Also, IRS financial reporting affects the financial reports of the government agencies for which IRS collects tax receipts, such as the Social Security Administration for the Social Security Trust Fund and the Department of Labor for the Unemployment Trust Fund. Beginning in fiscal year 1998, to meet federal accounting standards, IRS will have to disclose the reasons for any continuing noncompliance with the laws relating to the disposition of tax revenue to trust funds and the amount of over- or underfunding, if reasonably estimable.

As a central government financial management leader, it is essential for the Department of the Treasury to ensure that the problems IRS faces in preparing financial statements on its operations are promptly resolved so that these problems do not delay the preparation, or affect the credibility, of Treasury's agencywide financial statements. Also, unless IRS' financial management problems are dealt with, they will affect the ability to render an opinion on the governmentwide financial statements.

IRS FOLLOW-THROUGH WILL BE CRITICAL

In summary, it will be essential for IRS to follow-through and ensure that its planned short-term, interim actions are completed on schedule to improve the reliability of IRS' financial statements, and we will continue to work with IRS in doing so. We also will continue to monitor IRS' efforts to complete our recommendations and implement longer-term systems improvements. The Subcommittee's continued oversight of IRS' progress in implementing the CFO Act and preparing auditable financial statements will provide important impetus as well.

Mr. Chairman, this concludes my statement. now respond to any questions.

I would be happy to

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