Issue Area 1: The Internal Auditing Division Recovers Tax Revenue Cost Effectively But Enhanced Automation is Needed in Some Areas.
The Internal Auditing Division's mission is to conduct internal audits to verify the accuracy of tax returns and taxes owed the state, collect unpaid tax liabilities identified through internal audits, and expedite refunds due taxpayers. The Division has several units which review business and personal income tax returns. The Legislative Auditor reviewed three of these units: Corporate and Franchise Unit, Special Audits Unit, and the Excise Tax Unit. The Legislative Auditor's review of these units indicates that overall the Division recovers revenues cost effectively. However, there is a lack of automation in some areas which prevent further revenue recovery.
The Corporate and Franchise Unit is responsible for conducting internal audits on corporate net income tax and business franchise tax returns, issuing refunds, and recalculating State tax liabilities based on federal audits conducted by the Internal Revenue Service (IRS). Based on selection criteria, the Unit audits only about 5% of annual business tax returns. However, these audits produced an average collection of $1,463,584, and a reduction in refunds averaging nearly $6 million dollars annually. Based on the cost of the Unit to conduct these audits, the revenue benefit is $30 to $70 dollars per dollar in audit expenses over the last three years. Nevertheless, it is a serious deficiency that 95% of business tax returns do not receive at least a mathematical verification of the tax return. The Tax Department needs to implement a system in which all business tax returns receive at least a mathematical verification of the tax return.
The scope of the Excise Tax Unit was on the Health Care Provider tax, particularly on the new computer system prototype. Before the implementation of the computer system in February of 1998, Health Care Provider tax auditors were virtually unable to conduct audits due to limited resources available. This new prototype system has made the auditing process more efficient and effective which has allowed auditors to conduct audits, thus resulting in higher revenue collection. However, this prototype system has some deficiencies. The system currently cannot report the total amount of revenue generated from the audits conducted. Also, the system is unable to report the total amount of refunds that have been issued.
The focus of the Special Audits Unit was on the Individual Income Tax CP-2000 Underreporter Processing System, and audits based on Federal Revenue Agent Reports (RAR) received from the IRS. Overall, the process used by this Unit is automated and efficient. The Unit eliminated a previous backlog in audits. The CP-2000 and the Individual Income Tax RAR have an average collection of $623,120 annually for the last three fiscal years. The Unit has experienced a reduction in revenue recovery primarily because of a reduction in the number of RAR's received from the IRS.
The International Fuel Tax Agreement (IFTA) is an agreement between the 48 contiguous states and the 10 Canadian provinces that facilitates the reporting and payment of state motor carrier fuel use taxes. The fundamental principle of IFTA is to allow interstate motor carriers to report and pay such taxes to a single base jurisdiction, instead of registering with and paying each state in which the motor carriers operate.
According to reviews conducted by the International Fuel Tax Association, the State's IFTA program operates well and is in compliance with most procedural guidelines established by the Association. West Virginia has had two compliance reviews and both reviews indicated that the IFTA program was in compliance, with a few exceptions. The Division has already addressed many of the issues identified in the reviews. There presently is no risk of the State losing the authority to collect motor fuel use taxes or the loss of matching federal highway funds.
The Corporate and Franchise Unit should explore methods to provide greater automation for the corporate net income tax return and other business taxes to assist in auditing a greater percentage of returns. Also, the Division should assess its resources to verify if additional revenue recovery can be obtained cost effectively.
The Tax Department should give greater priority towards having modifications made to the Health Care Provider Tax computer system so that it is able to determine the total amount of audit revenue collected and the total amount of refunds issued through audits conducted.