REPORT DIGEST

 

DEPARTMENT OF REVENUE

 

FINANCIAL AUDIT

AND

COMPLIANCE EXAMINATION

For the Year Ended:

June 30, 2008

 

Summary of Findings:

Total this audit                        18

Total last audit                          9

Repeated from last audit           5

 

Release Date:

July 8, 2009

 

 

State of Illinois

Office of the Auditor General

WILLIAM G. HOLLAND

AUDITOR GENERAL

 

 

 

 

 

To obtain a copy of the Report contact:

Office of the Auditor General

Iles Park Plaza

740 E. Ash Street

Springfield, IL 62703

(217) 782-6046 or TTY (888) 261-2887

 

This Report Digest and Full Report
are also available on

the worldwide web at

http://www.auditor.illinois.gov

 

 

INTRODUCTION

 

      This report digest covers both the Financial Audit and State Compliance Examination of the Department of Revenue for the year ended June 30, 2008.  The Financial Audit and State Compliance Examination present a total of 18 findings.  Some of the more significant issues are summarized in this report digest.

 

SYNOPSIS

 

¨      The Department does not have sufficient processes and controls in place to ensure revenue recognition for financial reporting is proper for taxpayer credit-carry forward payments.

 

¨      After numerous audit tests, we noted the Department had problems regarding the accuracy of the accounts receivable calculated at June 30, 2008.

 

¨      The Department had numerous errors in accounting reports and draft financial statements that were given to the auditors.

 

¨      The Department did not appropriately consider or process taxpayer information received by June 30, 2008.  This impacted the financial reporting process and auditor adjustments to the financial statements were necessary. 

 

¨      The Department lacked adequate supervisory approval for large adjustments made to taxpayer accounts.  Further, the Department did not have an adequate procedure in place to monitor and investigate unusual balances in taxpayer accounts.

 

¨      The Department did not ensure that the development process and change management process for the new enterprise-wide computer tax system (GenTax) was properly controlled and documented.

 

¨      The Department did not have sufficient internal control over its new enterprise-wide computer tax system (GenTax) functions.

 

¨      The Department did not comply with the bonding requirements of Retailers’ Occupation Tax accounts as set forth in the Retailers’ Occupation Tax Act.

 

 

{Expenditures and Activity Measures are summarized on the next page.}

 

 

 


DEPARTMENT OF REVENUE

FINANCIAL AUDIT AND COMPLIANCE EXAMINATION

For the Year Ended June 30, 2008

 

EXPENDITURE STATISTICS

FY 2008

FY 2007

 

 

     Total Expenditures (All Funds)..................................

$9,720,909,202

$9,324,457,663

     OPERATIONS TOTAL................................................

         % of Total Expenditures............................................

$261,582,381

3%

$245,128,689

3%

         Personal Services......................................................

            % of Operations Total Expenditures........................

            Average Number of Employees.............................

$119,908,711

46%

2,101

$111,748,789

45%

2,089

         Other Payroll Costs (FICA, Retirement).......................

            % of Operations Total Expenditures........................

$36,897,741

14%

$28,936,710

12%

         Contractual Services...................................................

            % of Operations Total Expenditures...........................

$34,283,898

13%

$45,680,319

19%

         All Other Operations Items...........................................

            % of Operations Total Expenditures.................

$70,492,031

27%

$58,762,871

24%

 

 

 

     AWARDS & GRANTS, REFUNDS TOTAL............  

           % of Total Expenditures...........................................

 

$4,992,062,030

51%

$4,760,860,740

51%

     NON-APPROPRIATED FUNDS.................................

          % of Total Expenditures.....................................

 

$4,467,264,791

46%

$4,318,468,234

46%

     Total Deposits Remitted to the State Treasury

$33,567,993,439

$32,467,682,443

     Income Taxes...............................................................

         % of Total Revenues..................................................

$14,891,265,259

44%

$14,132,824,600

43%

     Sales Taxes..................................................................

         % of Total Revenues.................................................

$12,207,023,10336%

$11,678,859,678

36%

     Motor Fuel Taxes..........................................................

         % of Total Revenues................................................

$1,361,741,936

4%

$1,378,004,677

4%

     Public Utilities Taxes...................................................

         % of Total Revenues.................................................

$1,891,183,198

6%

$1,803,399,625

6%

     Other Collections.....................................................

         % of Total Revenues...............................................

 

$3,216,779,943

10%

$3,474,593,863

11%

PROPERTY AND EQUIPMENT at June 30,

 

$19,972,189

$21,108,346

SELECTED ACCOUNT BALANCES at June 30,

       Taxes Receivable....................................................

       Allowance for Uncollectible Taxes.........................

          Net Taxes Receivable.........................................

 

 

$1,920,705,000

     (592,275,000)

$1,328,430,000

 

$2,068,548,000

    (581,995,000)

$1,486,553,000

     DEPARTMENT DIRECTOR

     During Audit Period:   Brian A. Hamer

     Currently:  Brian A. Hamer



 

 

 

 

 

 

 

 

 

 

 

 


Deferred revenues were not properly accrued

 

 

 

 

 

 

 

 

 

 

 

Beginning fund balances and net assets were restated

 

 

 

 

 

 

 


Multi-million dollar adjustments needed to be made

 

 

 

 

 

 

 

 

 

$13 million in credits not recorded in financial statements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Department agrees with auditors

 

 

 

 

 

 

 

 

 


Accounts receivable adjusted by $87.6 million

 

 

 

 

 

 

 

 

 

 


High percentage of invalid receivable accounts

(TEST 1)

 

 

 

 

 

 

 

 

 

 

 

 

 Department’s own review identified problems with records

(TEST 2)

 

 

 

 

 

Payments were misapplied

 

 

 

 


Further testing by the Department and the Auditors continue to reflect problem

(TEST 3 and TEST 4)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Comparison of Business Income Tax accounts to the accounts receivable database identifies additional problems

(TEST 5)

 


Additional financial statement adjustments necessary totaling $26.1 million

 

 

 

 


Department agrees with auditors

 

 

 

 

 

 

 

 

 

 


Numerous errors in financial statements provided to auditors

 

 

 

Problems with financial information submitted to the Office of the State Comptroller

 

 

 

 

 

 

 

 


Motor Fuel Tax liabilities overstated and revenue understated by $9.7 million

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Net effect of errors

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Department agrees with the auditors

 

 

 

 

 

 

 


Significant increase in inventory levels

 

 


Significant backlog at June 30, 2008

 


Increase in backlog increases risk with financial statement reporting

 

 

BIT Taxpayer Notices

 

 

 

 

 

 

 

 

 

 

 

 

 


WIT Taxpayer Notices

 

 

 

 

 

 

 

 

 


Taxpayer information not processed timely

 

 

 

 

 

 

 

 

 

 


Testing by the Department and the auditors indicate problems with accounts receivable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Significant time noted in processing taxpayer correspondence

 

 

 

 

 


Information received by Department prior to June 30, 2008 affecting accounts receivable was not considered for financial statement reporting

 

 

 

 

 

 

 


Department agrees with auditors

 

 

 

 

Ineffective communication between Business Processing Division and the Financial Control Bureau

 

 

 

 

 


Data entry errors

 

 

 

 

 

No edits to detect taxpayer error

 

 

 

 

 

 

 

 

 

 

 

 


No edit checks to prevent payments made to future years in error

 

 

 

 

 

 

 

 

 


Some payments applied up to 20 or more years into the future

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Material adjustments made with no supervisory approval

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Contract maximum for GenTax is $49.2 million

 

 

 

 


Partial implementation in December 2007

 

 

 

 

 

 

 

 

 

 

 

 

 


Failure to run parallel systems during implementation

 

 

 

 

 

 

 

 

 

Lack of documentation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Internal control weaknesses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Problems with correspondence

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Department set bonds at zero in 1986

 

 

 

 

 

 

 

 

 

Department disagrees with auditors

 

 

 

 

 


AUDITOR’S COMMENT

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FINDINGS, CONCLUSIONS, AND

RECOMMENDATIONS

 

 

 

PROBLEMS WITH REVENUE RECOGNITION FOR FINANCIAL REPORTING

 

The Department of Revenue (Department) does not have sufficient processes and controls in place to ensure revenue recognition for financial reporting is proper for taxpayer credit-carry forward payments.

 

·        During our audit of Individual Income Tax (IIT) and Business Income Tax (BIT) returns for taxpayers with credit-carry forward amounts, we noted deferred revenues were not properly accrued for financial reporting purposes.  A credit-carry forward occurs when a business or individual taxpayer has a tax overpayment which they elect to apply to a subsequent tax period (as opposed to requesting a refund).  The Department’s procedure for income tax related liabilities was to accrue the lapse period refunds for business and individual income taxes.  This methodology resulted in revenue recognition during the current financial reporting period for all overpayments that were not refunded.  When a credit was requested to be carried to the next tax year by a taxpayer, the taxpayer intended that it be applied to a subsequent reporting period and used to offset tax liabilities of the subsequent period.  Thus, amounts received should have been accrued and deferred for financial reporting purposes.

 

This situation resulted in the overstatement of revenue and understatement of deferred revenue for four governmental funds as well as governmental activities, in the draft financial statements.  Because the Department had not previously adjusted its financial statements for the effects of credit-carry forward balances, a prior period adjustment was also necessary to restate beginning fund balances and net assets for the impact from previous years. 

 

In the draft financial statements provided to the auditors, income tax revenues were understated by approximately $71 million at June 30, 2008 for governmental funds and governmental activities. Deferred (unearned) revenues were understated by approximately $433 million for governmental funds and governmental activities. Also, beginning of the year fund balances/net assets were overstated by approximately $344 million for governmental funds and governmental activities.  Adjustments to record these credit-carry forward amounts were recorded in the final financial statements. 

 

·        During our audit of sales tax, and the related revenue and deferred revenue, we noted credits totaling $11.8 million from the legacy computer tax system had not been recorded as a liability at June 30, 2008 in the financial statements.  Although the amount of credits related to the sales tax types were converted to the new enterprise-wide computer tax system (GenTax) and were recorded, the adjustment was understated by approximately $1 million.  In total, credits of approximately $13 million related to sales tax (Department–wide total) were not recorded in the financial statements.  These amounts were deemed immaterial and were not recorded in the final financial statements.  (Finding 1, pgs. 10-13 of the Compliance report)

 

We recommended the Department strengthen its processes and procedures over financial reporting of credit-carry forward amounts.  The preparation of accounting estimates requires management to obtain sufficient data, make reasonable assumptions and continuously examine the appropriateness of amounts recorded.  Also, the Department should analyze historical data used, assess whether the data is comparative and consistent with data of the current period and consider if it can be relied upon in formulating a current estimate.  Further, relevant information such as the taxpayer’s estimated income tax liability, income tax refunds and credits to be applied to future periods should all be considered in determining earned and unearned revenue.  In addition, we recommended Revenue Accounting personnel be responsible for developing the income tax deferrals and revenues related to credit-carry forwards and ensure the methodology used to estimate the unearned revenue be re-examined annually. 

 

Department officials accepted the recommendation and stated they have changed the way it accounts for credit-carry forwards on year-end financial statements.  They stated that it is important to note that this change will have no impact on budgetary cash flows or revenues, which are accounted for on a cash basis.  The change, however, will better estimate the fiscal year to which a revenue should be credited.

 

 

 

 

INACCURATE ACCOUNTS RECEIVABLE REPORTING

 

After five separate audit tests, we noted problems regarding the accuracy of the accounts receivable calculation at June 30, 2008.  As a result of the inaccuracies found, accounts receivable was adjusted by $87,556,887 for the financial statements. 

 

During our testing, we originally reviewed two samples of Business Income Tax (BIT) and Withholding Income Tax (WIT) account detail to ensure the accuracy and existence of the Department’s June 30, 2008 accounts receivable information.  During the course of our review, we tested 25 of the highest dollar accounts receivable balances and a statistically selected sample of receivable account balances for both BIT and WIT data from the financial reporting accounts receivable data file.  The results of this testing are detailed below:

 

 

 

After our initial testing revealed a high percentage of invalid accounts, the auditors requested a listing of all cash payments received on the accounts receivable accounts from July 1, 2008 through December 31, 2008.  During the Department’s own review of the December 2008 payments received on the receivable balances, the Department noted a high percentage of the total payments received on various tax accounts were actually misapplied payments that had been received by the Department prior to June 30, 2008.  These payments were not applied to the correct accounts for various reasons, including taxpayer error.

 

This review showed that $1,730,938 or 82% of WIT payments received and $6,500,727 or 62% of BIT payments noted as received in December 2008 had been misapplied and should not have been a receivable as of June 30, 2008.

 

The Department then tested the top 100 tax accounts for WIT, BIT, and IIT and the auditors tested a statistical sample of accounts below the top 100 accounts for each tax type.  The results of this testing are detailed below as either a valid receivable or invalid receivable:             

 

 

Additionally, we also compared the Business Income Tax accounts, which were “excluded and not billed,” to the accounts receivable database, noting:

 

·        70 accounts totaling $118.6 million were not included in the accounts receivable; however, the Department had deducted them from the gross accounts receivable.

 

·        22 accounts were included in the accounts receivable database; however, the amounts the Department excluded did not agree to the accounts receivable amount, for a difference of $22.4 million.

 

·        As a result, an adjustment was made to the financial statements totaling $26.1 million, net of an allowance of $70.7 million.  (Finding 2, pgs. 14-17 of the Compliance report)

 

We recommended the Department evaluate the controls over taxes receivable and implement the necessary edits and controls to better identify valid accounts receivables to report in the financial statements. 

 

Department officials agreed to the recommendation and stated they have 
changed the way it makes estimates of accounts receivable on year-end 
financial statements.  They stated it is important to note this will have no 
impact on budgetary cash flows or revenues.  The Department has made 
the accounting change (reducing its gross receivables 4.9 percent on the 
FY08 financial statement) and will take steps to more expeditiously identify 
“invalid” accounts receivable, thereby also improving estimates of accounts 
receivable in the future.
 
 

ACCOUNTING REPORTS AND DRAFT FINANCIAL STATEMENTS NOT COMPLETE AND ACCURATE

 

The Department had numerous errors in accounting reports (Generally Accepted Accounting Principles (GAAP) package forms) and draft financial statements that were given to the auditors.

 

During our audit, we noted several errors that were made in compiling the GAAP package forms.  The GAAP package forms are required accounting reports that are submitted to the Office of the State Comptroller for State-wide reporting.  These GAAP package forms are also provided to the auditors where they function as a trial balance for the financial statement audit portion of the engagement. 

 

Based on our audit of amounts reported in the GAAP package forms and draft financial statements, we noted the following errors:

 

·        Nine cash accounts totaling approximately $17 million were not recorded as of June 30, 2008.  The unrecorded cash accounts ranged from ($80,000) to $13.6 million.  These amounts were deemed immaterial and were not recorded.

 

·        The Department used inaccurate reports to accrue Motor Fuel Tax credits.  This resulted in the overstatement of Motor Fuel Tax Fund liabilities by approximately $9.7 million and corresponding revenue was understated by $9.7 million.  This error was corrected for the final financial statements.

 

·        Taxes receivable and revenue were overstated in the General Fund by approximately $14.9 million due to an allocation error between taxes recorded in the General Fund and taxes recorded in Fund 719 - the Municipal Telecommunications Fund. These amounts were deemed immaterial and were not recorded.

 

·        During our audit of income taxes and the related revenue and deferred revenue, we noted that a duplicate entry was made in the amount of $2.2 million to record accounts receivable for amounts “in protest”.   Amounts “in protest” are the tax assessments, penalties and interest where the taxpayer is disputing the amount.  Also, additional amounts for allocated and unallocated Business Income Tax were not correct and resulted in an understatement of receivables and revenues totaling approximately $1 million. 

 

The net effect of these errors was an overstatement of $1.2 million for taxes receivable and income tax revenue (Department-wide).  These amounts were deemed immaterial and were not recorded. (Finding 3, pgs. 18-20 of the Compliance report)

 

We recommended the following:

·        The Department should institute new procedures for preparing the GAAP package forms which includes supervisory review of all supporting schedules and reports used in the formation of accruals and adjustments, as well as supervisory review of the completed GAAP packages, prior to submitting them to the Office of the State Comptroller. 

·        All cash accounts should be reviewed to ensure they are properly recorded in the GAAP package forms.

·        Reports used for recording Motor Fuel Tax liabilities should be reviewed to ensure the reports are complete and accurate.

·        Entries to adjust allocations between the General Fund and the Telecommunications Tax Fund should be made to both funds.

·        The process for determining taxes receivable, tax revenue, and deferred revenue for the governmental funds should be re-evaluated.  The current process is primarily manual and complex and involves several electronic spreadsheets.  As such, it is highly susceptible to errors.  At a minimum, the spreadsheets used to calculate these amounts should be reviewed by a supervisor and all amounts should be compared to the underlying documentation used in its preparation.

 

Department officials agreed with the recommendation.  They will more closely review financial reports before they are transmitted to the Office of the State Comptroller and the external auditors.

 

TAXPAYER INFORMATION NOT CONSIDERED OR PROCESSED TIMELY

 

The Department did not consider or process taxpayer information received by June 30, 2008.  This impacted the financial reporting process and adjustments to the financial statements were necessary.  The Department converted to a new enterprise-wide computer tax system (GenTax), which went into production December 2007.  As a result, the Department experienced a significant increase in the backlog of processing Business Income Tax (BIT) and Withholding Income Tax (WIT) information. 

 

At June 30, 2008, the Department had incurred a significant backlog of taxpayer information relating to BIT accounts and WIT accounts.  The Department provided the following charts to illustrate the inventory levels for the past few years at June 30th of each year.  The increase in unprocessed taxpayer information prior to fiscal year-end increases the likelihood the information utilized for financial statement preparation could be misstated.  As indicated, the backlog was significantly higher at June 30, 2008 than the previous years.

 

Source: Department of Revenue – Business Processing Division

 

      Source: Department of Revenue – Business Processing Division

 

 

During our detailed testing of accounts receivable we noted several accounts where the taxpayer had provided the Department additional or corrected information; however, the information had not been processed by the Department as of June 30, 2008. 

 

The Department tested the top 100 tax accounts receivable for WIT, BIT, and Individual Income Tax (IIT) and the auditors tested a statistical sample of accounts below the top 100 accounts for each tax type.  The auditors reviewed the accounts to determine if the accounts would be resolved once the information was processed by the Department, resulting in no cash being received and therefore, an invalid accounts receivable at June 30, 2008.  The results of this testing are detailed below:

Of the accounts receivable identified as invalid due to backlog for the top 100 sample and the statistical samples identified above, we noted the time to process the accounts was significant.  The following chart depicts the number of days to process the invalid due to backlog accounts in our samples:

 

Days to Process

WIT

Invalid due to backlog

BIT

Invalid due to backlog

IIT

Invalid due to backlog

0-30 days

 

1

 

0

 

0

31-90 days

 

2

 

0

 

3

91-180 days

 

24

 

6

 

4

181 days and over

 

44

 

36

 

1

Total Invalid due to backlog

 

71

 

42

 

8

 

 

 

 

 

 

 

Total samples tested

 

132

 

122

 

124

 

As a result, the reports of taxpayer accounts generated for the period ending June 30, 2008 to support the accounts receivable for financial reporting did not accurately reflect information received by the Department because the Department did not consider the information received prior to June 30, 2008 that would be material to the financial statements, but was not processed as of fiscal year-end.  (See Finding 08-2) (Finding 4, pgs. 21-24 of the Compliance report)

 

We recommended the Department take action to ensure taxpayer information is timely considered or processed to ensure taxpayer’s records and financial statement information reflects accurate information.  Further, we recommended that material account balances be up to date, including the review of all received information for possible adjustments to accounts.

 

Department officials agreed with the recommendation and stated they made a business decision which they believe was compelling to accept a temporary increase in some inventories in order to bring on line a new tax system. 

 

LACK OF SUPERVISORY APPROVAL FOR LARGE ADJUSTMENTS TO TAXPAYER ACCOUNTS

 

The Department lacked adequate supervisory approval for large adjustments made to taxpayer accounts.  Further, the Department did not have an adequate procedure in place to monitor and investigate unusual balances in taxpayer accounts.  Material adjustments and issues were not effectively communicated between the Business Processing Division and the Financial Control Bureau.

 

      During our testing of Withholding Income Tax (WIT) accounts, we 
      found the following deficiencies in the Department’s controls and
      processing:

 

·        8 of 66 (12%) receivable accounts tested, totaling $4,109,359, were the result of data entry errors made by the Department in entering taxpayer information.  All of these accounts were originally included in the accounts receivable calculation for the financial statements.  For example, one taxpayer’s tax liability was entered at $1,109,643 when it should have been entered as $109,643.  No procedures were in place to monitor unusual account balances or discrepancies between payments claimed to payments received.

 

Upon auditor inquiry, the Department stated there were no edits to suspend unusual balances for review at the time these accounts were entered.

 

·        3 of 66 (5%) accounts tested had payments that were received by the Department, but were held in pending due to an error in the tax liability period by the taxpayer.  These pending payments were not reflected in the taxpayers’ account balances in the new GenTax system since they were not associated with the right tax liability.  Any payment received by the Department that is not associated with a tax return gets suspended until it is manually posted or a return is filed.  All three accounts receivable balances were resolved once the payments were manually posted.

 

For two of these accounts, the taxpayer erroneously applied the payments to a future quarter of withholding income tax where a return was not yet posted.  There is not an edit in place to prevent taxpayers from applying payments to future quarters for withholding income tax. 

 

Upon further analysis, the auditors discovered the following payments that were in excess of one tax liability period into the future:

 

 

 

  • For 1 of 66 (2%) receivable accounts tested, totaling $1,755, was an invalid accounts receivable account created as a result of a user error combined with an erroneous non-filer notice being sent to a taxpayer.  The erroneous notices were the result of the GenTax conversion problem with purged 2002 and 2003 Withholding Income Tax (WIT) data. 

 

In following up on this exception, the auditors determined the accounts receivable data contained 58 additional withholding receivables that were erroneously included, totaling $291,772. 

 

In addition to the deficiencies noted above, the Department does not have adequate controls over account adjustments and changes.  In testing WIT and Business Income Tax (BIT), the auditors noted that high dollar adjustments were made to various accounts with no review or supervisory approval noted.  Due to taxpayer accounts potentially being a receivable or liability for the State of Illinois, supervisory approval for material adjustments to taxpayer accounts would assist the Department in identifying potential problems with the reporting functions.  The material adjustments made by the Business Processing Division should also be communicated to the Financial Control Bureau of the Department for evaluation and financial statement impact.

 

·        9 of 25 (36%) of the top 25 WIT accounts receivable were adjusted by amounts ranging from $326,623 to $1,741,101 with no evidence of supervisory review or approval.

 

·        6 of 25 (24%) of the top 25 BIT accounts receivable were adjusted by amounts ranging from $2,911,425 to $13,428,965 with no evidence of supervisory review or approval. (Finding 7, pgs. 30-33 of the Compliance report)

 

We recommended the Department evaluate the controls over WIT accounts and implement necessary edits and controls to identify the processing problems in a timely manner.  Further, the Department should implement a supervisory authorization and review for material adjustments to taxpayer accounts.  Additionally, we recommended that all material adjustments be communicated between the Business Processing Division and the Financial Control Bureau for consideration in the financial statement reporting process.

 

Department officials agreed with the recommendation, again noting that the impact is on year-end financial statements not on budgetary revenues or cash flows. 

 

 

WEAKNESSES IN THE DEVELOPMENT AND CHANGE MANAGEMENT PROCESS IN IMPLEMENTING THE NEW COMPUTER TAX SYSTEM

 

The Department did not ensure that the development process and change management process for its new enterprise-wide computer tax system (GenTax) was properly controlled and documented.  In addition, the Department had not utilized its historic practice of following its Project Control Methodology to promote effective and controlled development of GenTax. 

 

After a competitive procurement process, the Department entered into a contract with a vendor for the development of an integrated tax system named GenTax.  The contract was signed in October 2006 and continues through June 2012.  The contract maximum is approximately $49.2 million and through fiscal year 2008, the Department had paid approximately $13.2 million.

 

In December of 2007, the Business Income Tax, Withholding Income Tax, and Sales Tax systems went into production and replaced the applicable legacy systems.  For the fiscal year ended June 30, 2008, GenTax processed over $15 billion of tax collections, as well as other transactions.

 

Some of the weaknesses noted during our review follow:

 

·    Development Methodology - The vendor supplied its own development methodology; however, our review of the documentation found that it was not generally followed.  In particular, required reviews and approvals of deliverables by Department staff were not obtained.

 

·     Data Conversion – Documentation to support the accuracy of converting data from the legacy system to GenTax was not provided. 

 

·        Parallel System Tests - A standard systems development practice is to run parallel (process transactions on the new and old system to verify the accuracy of results) for a period of time.  The Department did not run GenTax parallel with the legacy system prior to the cutover to certain GenTax modules on December 7, 2007.

 

·        User Testing Documentation – Documentation to adequately support the adequacy and completion of user testing was not provided. 

 

·        Vendor Testing – A system test approach was developed by the vendor; however, documentation to support the completion of the testing was not provided.

 

·        System and User Documentation – There was a general lack of documentation in all phases and areas to support the development, maintenance, and use of the system.

 

·        Reliance on Vendor – The transfer of knowledge from the vendor to the Department had not been effectively accomplished, even though major portions of the system had been in production since December 7, 2007.

 

In addition, rather than using the Department’s established standard, a less rigid change management process was utilized for GenTax.

 

Although portions of GenTax were in production, an effective change management process was not followed.  The process to control changes to GenTax did not meet the requirements outlined the in the Department’s standard and was not always followed. (Finding 8, pgs. 34-36 of the Compliance report)

 

We recommended the Department ensure the development of the critically important GenTax is effectively controlled and documented.  In particular, the Department should:

 

·        Ensure all required steps in the development process are completed, reviewed, approved, and documented prior to system implementation.

·        Ensure the accuracy of converting data from the legacy system to GenTax is monitored, reviewed, approved, and documented.

·        Ensure appropriate system and user testing is conducted, reviewed, approved, and documented prior to system implementation.

·        Ensure adequate system and user documentation is available to support the development, maintenance, and use of the system.

·        Accelerate the transfer of knowledge from the vendor to the Department.

·        Ensure all required steps in an effective change management process are utilized with GenTax.

·        Ensure all changes are adequately reviewed, tested, approved, and documented prior to system implementation.

 

Department officials agreed with the recommendation and with the need for effective development controls and documentation. 

 

 

DEFICIENCIES IN THE NEW ENTERPRISE-WIDE COMPUTER TAX SYSTEM

 

The Department of Revenue (Department) did not have sufficient internal control over the new enterprise-wide computer tax system (GenTax) functions, which affect the integrity of processing taxpayer information, financial data, and financial reporting. 

 

During our review, we identified a myriad of deficiencies in the production modules of GenTax.  Some of the deficiencies noted follow:

 

·        The capability to enter some return types was not available which led to the creation of backlog returns waiting for entry into GenTax.  Per Department management, a decision was made to delay the implementation of the capability; however, documentation to support the decision was not provided to the auditors.

 

·        Information on several screens was not accurate and staff was told not to provide the information to the taxpayer. 

 

·        The system did not allow a 10 year carry back period for net loss deduction, causing some taxpayer accounts to be inaccurate. 

 

·        Allocations for the disbursements of taxes to local governments were inaccurate. 

 

·        Numerous problems with system generated correspondence.  Some of the problems included:

  •          Inaccurate letters sent to taxpayers where the notice of tax amount in the letter did not equal the dollar amount in GenTax.

  •          Over 3,200 taxpayers received conflicting letters as one letter stated the taxpayer had a credit while another letter stated the taxpayer owed the State.

  •          In February and March of 2008, approximately 84,000 letters were generated from GenTax which contained erroneous information.  The problem was identified from an independent manual review and letters correcting the error had to be generated.  This error cost the State approximately $29,000 to correct. (Finding 9, pgs. 37-39 of the Compliance report)

 

We recommended the Department perform a thorough review of the modules of GenTax currently in production.  From a general perspective, the Department must ensure the system provides the required functionality, integrity, and accuracy to support taxpayer information, financial data and reporting.  Specifically, the Department should:

 

·           Ensure the capability to enter all return types is implemented.

·           Ensure the accuracy of all screens.

·           Ensure the system allows the 10 year carry back period for net loss deductions.

·           Ensure the accuracy of local government allocations. 

·           Ensure the accuracy of all system generated correspondence. 

 

Department officials agreed and stated they have implemented the recommendation. 

 

NONCOMPLIANCE WITH RETAILERS’ OCCUPATION TAX ACT

 

The Department of Revenue (Department) did not comply with the bonding requirements of Retailers’ Occupation Tax (ROT) accounts as set forth in the Retailers’ Occupation Tax Act (Act) (35 ILCS 120/2a).

 

The Act requires every applicant for a certificate of registration for any person in the business of selling tangible personal property at retail in this State, at the time of filing such application, to furnish either:

 

·        a bond from a surety company authorized to do business in the State of Illinois,

 

·        an irrevocable bank letter of credit or a bond signed by two personal sureties who have filed with the Department sworn statements disclosing net assets equal to at least three times the amount of the bond to be required of such applicant, or

 

·        a bond secured by an assignment of a bank account or certificate of deposit, stocks or bonds, conditioned upon the applicant paying to the State of Illinois all moneys becoming due under this Act and under any other State tax law or municipal or county tax ordinance or resolution under which the certificate of registration that is issued to the applicant under this Act will permit the applicant to engage in business without registering separately under such other law, ordinance or resolution.

 

The Act requires the Department to fix the amount of such security in each case, taking into consideration the amount of money expected to become due from the applicant under this Act and under any other State tax law or municipal or county tax ordinance or resolution under which the certificate of registration that is issued to the applicant under this Act will permit the applicant to engage in business without registering separately under such other law, ordinance or resolution.

 

·        The amount of security required by the Department is such as, in its opinion, will protect the State of Illinois against failure to pay the amount which may become due from the applicant under this Act and under any other State tax law or municipal or county tax ordinance or resolution under which the certificate of registration that is issued to the applicant under this Act will permit the applicant to engage in business without registering separately under such other law, ordinance or resolution,

 

·        The amount of the security required by the Department does not exceed three times the amount of the applicant’s average monthly tax liability, or $50,000, whichever amount is lower.

 

The Department provided a memo dated July 25, 1986 in which the Department eliminated the ROT bonding requirements.  The memo was signed and approved by the Director at that time.  The Department stated instead of seeking a statutory change in 1986 mandating bonds at zero, the Department exercised its administrative discretion to set bonds at zero, which the Department believes is consistent with the bonding authority granted in Section 2a of the Act. (Finding 18, pgs. 54-58 of the Compliance report)

 

We recommended the Department follow the requirements for Retailers’ Occupation Tax applications as set forth in 35 ILCS 120/2a or seek a legislative remedy.

 

Department officials disagreed with the finding. The Department’s tax counsel have advised that, with respect to setting the level of surety bonds, the Department is in compliance with the Retailers’ Occupation Tax Act.

 

 

Auditor’s Comment

 

The statute requires every person engaged in the business of selling tangible personal property at retail to obtain a certificate of registration from the Department.  At the time of filing an application for a certificate of registration, each person is required to provide some form of specified security.  35 ILCS 120/2a.  Contrary to statute, the Department does not require any applicants to file any form of security.

 

The statute does accord the Department some discretion in determining the appropriate amount of the required security, provided it sets an amount “taking into consideration the amount of money expected to become due from the applicant” and that the amount set be sufficient to “protect the State of Illinois against [the applicant’s] failure to pay” applicable taxes.

 

While the Department argues that its “zero bond’ policy meets the statutory criteria, we would note that the statute gives the Department discretion in setting the amount of the security but not in determining whether security is to be filed at all.  Further, the Department’s discretion in setting the amount of the security is not unbridled; in fact, the Department must set an amount based on the estimated amount expected to be due from the applicant and necessary to protect the State against the applicant’s failure to pay.  The auditors would note that the Department’s gross receivables for ROT at June 30, 2008 on the Quarterly Summary of Accounts Receivable submitted to the Office of the Comptroller totaled approximately $311,536,000.  Of this amount, approximately $249,079,000 is over 180 days past due and the likelihood of collection by the State is remote.  If a bond or other form of security were held by the Department in these cases, the State would have some alternative recourse to pursue the satisfaction of the outstanding amount due.

 

 

OTHER FINDINGS

     

The remaining findings are reportedly being given attention by the Department.  We will review the Department’s progress towards implementing our recommendations during the next audit period.

 

 

AUDITORS’ OPINION

 

Our auditors stated the financial statements of the Department of Revenue as of June 30, 2008, and for the year then ended are fairly presented in all material respects.

 

 

STATE COMPLIANCE EXAMINATION – ACCOUNTANT’S REPORT

 

      The auditors qualified their report on State Compliance for findings 08-1 through 08-4 and 08-7 through 08-9.  Except for the noncompliance described in these findings, the auditors state the Department complied, in all material respects, with the requirements described in the report.

 

 

 

 

____________________________________   

WILLIAM G. HOLLAND, Auditor General

WGH:CL:pp

 

 

AUDITORS ASSIGNED

 

      The compliance examination was performed by the Auditor General’s staff.  McGladrey & Pullen, LLP were our special assistant auditors for the financial audit.