The Internal Revenue Service (IRS), along with other components of the Department of the Treasury, collects and distributes excise tax receipts to government trust funds. As the nation's tax collector, IRS plays a critical role in this process. Consequently, trust funds and their administrators depend on IRS to have sound procedures and controls over this process to ensure that excise taxes are appropriately distributed. This report is a follow-up to two reports we recently issued discussing procedures we performed to assist the Department of Transportation's Office of Inspector General (Transportation IG) in ascertaining whether the net excise tax collections and excise tax certifications reported by IRS for the fiscal year ended September 30, 2002, were supported by underlying records. The agreed-upon procedures, along with our audit of IRS's fiscal year 2002 financial statements, provided a sufficient basis to assist the Transportation IG in forming an opinion on the departmentwide financial statements and the financial statements of the trust funds administered by the department, including the Highway Trust Fund and the Airport and Airway Trust Fund.

IRS's internal controls over its process for certifying excise taxes for distribution to federal government trust funds are not fully effective in ensuring that the appropriate amounts are distributed to the trust funds. Our work identified several internal control issues that affected the amounts distributed to trust funds quarterly and that could have affected total fiscal year distributions if IRS had not corrected errors resulting from these control issues after we brought them to its attention. We identified several issues. IRS lacked effective procedures to timely detect errors made by employees when entering excise tax return information into its information systems. IRS did not detect such errors until months after they occurred. As a result, IRS understated certified collections to the Highway Trust Fund for the quarters ended December 31, 2001, and March 31, 2002. Although IRS subsequently identified and corrected the errors, it would not have had adequate time to correct them if these errors had occurred later in the fiscal year. Had that been the case, the amount of excise taxes distributed to the Highway Trust Fund would have been less than it should have been for fiscal year 2002. IRS lacked effective supervisory review to timely detect errors made in the preparation of excise tax certifications. As a result, amounts certified to trust funds were misstated for certain quarters during both fiscal years 2002 and 2001. IRS corrected the errors in the certifications after we brought them to its attention. Had we not identified the errors during our review and notified IRS, the amounts distributed to the Highway Trust Fund would have been approximately $81 million less than they should have been during fiscal year 2002 and approximately $1 million less than they should have been during fiscal year 2001. IRS did not effectively coordinate with other components of Treasury involved in the excise tax distribution process when it implemented changes to its method for recording excise tax credits in fiscal year 2002. As a result, IRS's system-generated certification data were not in a format usable by the Financial Management Service (FMS) or the Bureau of the Public Debt (BPD) to facilitate the recording of adjustments to trust funds. To make the data usable to FMS and BPD, IRS had to add steps to its certification process to generate the information in the previous reporting format. These added steps made IRS's already complex certification process even more cumbersome, increasing both the likelihood that errors could be made and that they could go undetected by supervisory review. In addition to these issues, we continued to find that IRS did not promptly certify excise tax collections to the trust funds. Under IRS's current certification process, excise tax receipts for the fourth quarter of the fiscal year, which ends September 30, are not certified until the following March. Because the Department of Transportation's financial statements are currently required to be issued by February 1 of the following year,5 adjustments to initial distributions of excise tax receipts for the last quarter of the fiscal year, based on IRS's certification, are not recorded in time to be reflected in the trust funds' financial statements. However, this lag time in making final adjustments will become more of an issue this year. Beginning with its fiscal year 2004 accountability report, the Department of Transportation, along with the other CFO Act agencies, will be required to issue its report, including its audited financial statements, by November 15, 2004.

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