Internal Revenue Service
Challenges Remain in Combating Abusive Tax Schemes Gao ID: GAO-04-50 November 19, 2003Abusive tax avoidance schemes could threaten our tax system's integrity and fairness if honest taxpayers believe that significant numbers of individuals are not paying their fair share of taxes. Abusive schemes encompass such distortions of the tax system as falsely describing the law (saying, for example, that the income tax is unconstitutional), misrepresenting facts (for instance, promoting the deduction of personal expenses as business expenses), or using trusts or offshore bank accounts to hide income. As agreed, this report focuses on three objectives. They are to (1) describe the nature and scope of abusive tax avoidance schemes as determined by the Internal Revenue Service (IRS), (2) describe IRS's strategy to combat these schemes and the performance goals and measures IRS uses to track its major effort related to them, and (3) describe how IRS determined the amount and source of staff resources to be devoted to these schemes in the IRS operating division most directly affected.
Abusive schemes vary in nature, and new ones continually emerge, making it very difficult to measure their extent. IRS has been gathering information to better define the scope of abusive schemes. In addition to 131,000 participants linked to abusive schemes between October 1, 2001, and mid- August 2003, IRS officials estimated that several hundred thousand others likely are engaged in abusive schemes. However, IRS documented this estimate only when GAO asked. Documentation can help policymakers judge the appropriateness of IRS resources and strategy in combating the high-priority abusive scheme problem. IRS's broad-based strategy for addressing abusive schemes included: (1) targeting promoters to head off the proliferation of abusive schemes and to identify taxpayers taking advantage of them; (2) offering inducements to taxpayers to come forth and disclose their use of questionable offshore tax practices; and (3) using performance indicators to measure outputs and intending to continue down the path it has started and develop long-term process and results-oriented performance goals and measures linked to those goals. The lack of these latter elements impedes gauging IRS's progress in combating abusive schemes. Using a systematic agencywide decision-making process, IRS planned to shift significant resources to support its strategy, but the level of resources likely to be used in fiscal year 2003 was less than expected due to overly optimistic workload forecasts caused by inexperience with the types of cases involved. Future resource usage remains to be seen, given uncertainty about how much abusive scheme work IRS will have and how long it will take to close cases. IRS's understanding of how many staff will be needed to address the problem over what period will continue to evolve as IRS gains a better understanding of the problem's scope.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-04-50, Internal Revenue Service: Challenges Remain in Combating Abusive Tax Schemes
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Report to the Chairman and Ranking Minority Member, Committee on
Finance, U.S. Senate:
November 2003:
Internal Revenue Service:
Challenges Remain in Combating Abusive Tax Schemes:
GAO-04-50:
GAO Highlights:
Highlights of GAO-04-50, a report to the Chairman and Ranking Minority
Member, Committee on Finance, U.S. Senate
Why GAO Did This Study:
Abusive tax avoidance schemes could threaten our tax system‘s
integrity and fairness if honest taxpayers believe that significant
numbers of individuals are not paying their fair share of taxes.
Abusive schemes encompass such distortions of the tax system as
falsely describing the law (saying, for example, that the income tax
is unconstitutional), misrepresenting facts (for instance, promoting
the deduction of personal expenses as business expenses), or using
trusts or offshore bank accounts to hide income.
As agreed, this report focuses on three objectives. They are to (1)
describe the nature and scope of abusive tax avoidance schemes as
determined by the Internal Revenue Service (IRS), (2) describe IRS‘s
strategy to combat these schemes and the performance goals and
measures IRS uses to track its major effort related to them, and (3)
describe how IRS determined the amount and source of staff resources
to be devoted to these schemes in the IRS operating division most
directly affected.
What GAO Found:
Abusive schemes vary in nature, and new ones continually emerge,
making it very difficult to measure their extent. IRS has been
gathering information to better define the scope of abusive schemes.
In addition to 131,000 participants linked to abusive schemes between
October 1, 2001, and mid-August 2003, IRS officials estimated that
several hundred thousand others likely are engaged in abusive schemes.
However, IRS documented this estimate only when GAO asked.
Documentation can help policymakers judge the appropriateness of IRS
resources and strategy in combating the high-priority abusive scheme
problem.
IRS‘s broad-based strategy for addressing abusive schemes included:
* targeting promoters to head off the proliferation of abusive
schemes and to identify taxpayers taking advantage of them;
* offering inducements to taxpayers to come forth and disclose their
use of questionable offshore tax practices; and
* using performance indicators to measure outputs and intending to
continue down the path it has started and develop long-term process
and results-oriented performance goals and measures linked to those
goals. The lack of these latter elements impedes gauging IRS‘s
progress in combating abusive schemes.
Using a systematic agencywide decision-making process, IRS planned to
shift significant resources to support its strategy, but the level of
resources likely to be used in fiscal year 2003 was less than
expected due to overly optimistic workload forecasts caused by
inexperience with the types of cases involved. Future resource usage
remains to be seen, given uncertainty about how much abusive scheme
work IRS will have and how long it will take to close cases. IRS‘s
understanding of how many staff will be needed to address the problem
over what period will continue to evolve as IRS gains a better
understanding of the problem‘s scope.
What GAO Recommends:
GAO recommends that when IRS prepares future estimates of the size of
the abusive scheme problem, the Commissioner of Internal Revenue
document the support underlying the estimates. In written comments on
a draft of this report, the Commissioner agreed with this
recommendation.
www.gao.gov/cgi-bin/getrpt?GAO-04-50.
To view the full product, including the scope and methodology, click
on the link above. For more information, contact Michael Brostek at
(202) 512-9110 or brostekm@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Nature of Abusive Schemes Varies and Their Scope Is Unknown:
IRS Strategy to Combat Abusive Schemes Is Broad-Based, but Has No Long-
term Performance Goals or Measures Linked to Goals:
IRS Planned Resource Shifts Are Significant, but Resource Use Started
Slowly and Future Use Remains to Be Seen:
Conclusions:
Recommendation to the Commissioner of Internal Revenue:
Agency Comments:
Appendix:
Appendix I: Comments from the Internal Revenue Service:
Tables:
Table 1: Descriptions of Abusive Scheme Categories:
Table 2: Comparison of Different Estimates of the Number of Taxpayers
Involved in Abusive Schemes:
Table 3: Planned Shift in Revenue Agent and Tax Compliance Officer FTE
Positions Devoted to Abusive Scheme Priority Areas, Fiscal Years 2002-
2004:
Table 4: Planned and Projected Revenue Agent and Tax Compliance Officer
FTEs Devoted to Abusive Scheme Priority Areas, Fiscal Year 2003:
Table 5: Comparisons of Inventory Developments with Inventory
Expectations:
Letter November 19, 2003:
The Honorable Charles E. Grassley:
Chairman:
The Honorable Max Baucus:
Ranking Minority Member:
Committee on Finance:
United States Senate:
Abusive tax schemes encompass such distortions of the tax system as
falsely describing the law (saying, for example, that the income tax is
unconstitutional), misrepresenting facts (for instance, promoting the
deduction of personal expenses as business expenses), or using trusts
or offshore bank accounts to hide income. During an April 2002 hearing
before the Senate Committee on Finance, we testified about the inexact
process for estimating the extent of abusive schemes used by individual
taxpayers.[Footnote 1] We pointed to Internal Revenue Service (IRS)
estimates that about 740,000 taxpayers had used certain types of
abusive schemes in tax year 2000, and that $20 billion to $40 billion
in improper tax avoidance or tax credit and refund claims had occurred
that IRS had not yet been able to identify and address. We noted that
abusive schemes could threaten our tax system's integrity and fairness
if honest taxpayers believe that significant numbers of individuals are
not paying their fair share of taxes.
The estimated 740,000 taxpayers consisted of estimates of the number of
taxpayers in four major scheme areas--about 62,000 with frivolous
returns, 105,000 with frivolous refunds, 65,000 using abusive domestic
trusts, and 505,000 using offshore schemes. Of the 505,000 taxpayers
estimated to use offshore schemes, IRS estimated 500,000 were abusing
offshore credit cards. In our testimony, we discussed how IRS arrived
at its estimates. We also understand that some of the estimates
reflected high-end numbers, for example, the numbers of taxpayers who
were associated with a particular abusive promoter, but not necessarily
reflecting an abusive scheme on their tax returns.
The $20 billion to $40 billion estimate of taxes not identified and
addressed related to offshore schemes. Saying there were no reliable
data to predict tax implications, IRS derived its estimate based on
average dollars in other parts of the abusive tax scheme program.
As agreed, this report focuses on three objectives. They are to (1)
describe the nature and scope of abusive tax avoidance schemes as
determined by IRS, (2) describe IRS's strategy to combat these schemes
and the performance goals and measures IRS uses to track its major
effort related to them, and (3) describe how IRS determined the amount
and source of staff resources to be devoted to these schemes in the IRS
operating division most directly affected. To do our work, we (1)
analyzed IRS and other scheme reports, publications, data, and other
documentation providing insight into the characteristics, complexity,
size, and type of the problem, (2) reviewed IRS planning documents with
information on IRS strategies, measures, milestones, and resources, (3)
compared the contents of IRS planning documents to Government
Performance and Results Act of 1993[Footnote 2] (GPRA) criteria on what
elements strategic planning should include, and (4) interviewed agency
officials about their views on, among other things, the problem's
nature and scope and IRS's strategy. We did our work from September
2002 through September 2003 in accordance with generally accepted
government auditing standards.
Results in Brief:
Abusive schemes vary in nature, and new ones continually emerge, making
it very difficult to measure their extent. IRS has been gathering
information to better define the scope of abusive schemes. In addition
to 131,000 participants who were linked to abusive schemes between
October 1, 2001, and mid-August 2003, IRS officials estimated that
several hundred thousand additional taxpayers likely are engaged in
abusive schemes. Officials have not estimated how many tax dollars
might be involved overall. IRS's estimate of those involved is
primarily based on promoter-related information developed in the past
year and includes only those offshore credit card cases where IRS
believes individuals' names are likely to be identified. Although they
did not originally have documentation supporting this estimate, upon
request, IRS officials prepared documentation for us showing the
estimate's derivation. Documenting the basis for key program-related
numbers ensures that others can judge their reliability and better
understand what may account for differences in such key numbers over
time. IRS continues to believe abusive schemes represent a significant
compliance problem that deserves considerable attention, and schemes
remain a top enforcement priority.
IRS's broad-based strategy for addressing abusive schemes included the
following:
* targeting promoters to head off the proliferation of abusive schemes
and to identify taxpayers taking advantage of them;
* offering inducements to taxpayers to come forth and disclose their
use of questionable offshore tax practices;
* focusing attention on identifying schemes, alerting the public, and
enforcing the law, including partnering with states to share
information on abusive schemes;
* promoting the coordination of efforts throughout IRS; and:
* using performance indicators to measure outputs and intending to
continue down the path it has started and develop long-term process and
results-oriented performance goals and measures linked to those goals.
The lack of these latter elements impedes gauging IRS's progress in
combating abusive schemes.
IRS is in the midst of its efforts to implement its abusive scheme
strategy and has had to make decisions about staff allocations and what
can be accomplished on the basis of available information. Using a
systematic agencywide decision-making process, IRS planned to shift
resources, significantly in the case of examination resources, to
support its strategy, but the level of resources used in fiscal year
2003 through July 31 and likely to be used in fiscal year 2003 as a
whole was less than expected due to overly optimistic workload
forecasts caused by inexperience with the types of cases involved. The
extent to which the caseload and resources will match each other in the
future remains to be seen, given the uncertainty about the volume of
additional work and the rate at which IRS can close abusive scheme
examinations. IRS's understanding of how many staff will be needed to
address the program and how long staff will take to work through the
cases will continue to evolve as IRS gains a better understanding of
the scope of abusive schemes.
To ensure that support for future IRS estimates of the size of the
abusive scheme problem exists, we are recommending that IRS document
the support when preparing the estimates.
In written comments, the Commissioner of Internal Revenue agreed with a
draft of this report. He specifically agreed with the recommendation
and said that IRS would establish a methodology for documenting the
basis for the estimates. He also affirmed IRS's intention to establish
measurable process and results-oriented goals and said that developing
these measures is an operational priority for fiscal year 2004.
Background:
In a June 2002 letter, the Secretary of the Treasury addressed various
questions posed by the then Ranking Member of the Committee on Finance
on IRS actions to address abusive schemes. Treasury's letter pointed to
IRS's Small Business/Self-Employed (SB/SE) Division as having primary
responsibility for abusive schemes marketed to individuals and small
businesses.
Within SB/SE, several units have established combating abusive schemes
as a top priority. The Office of Reporting Enforcement was established
in 2002 to increase program oversight and to help information flow
among programs that address abusive schemes. SB/SE's collection
component is to work closely with the examination function to ensure
coordination. Its Taxpayer Education and Communication unit has
launched a countermarketing strategy against abusive tax schemes and
their promoters. Its Communications and Liaison unit is responsible for
developing communication messages and strategies to maintain and
enhance ongoing IRS interaction with internal and external
stakeholders.
Other IRS organizations are also involved with abusive schemes. For
instance, Criminal Investigation (CI) works closely with SB/SE and
investigates and pursues promoters and individuals using schemes. The
Office of Chief Counsel provides legal services, such as publishing
guidance, working with examination and collection activities, and
pursuing litigation.
Nature of Abusive Schemes Varies and Their Scope Is Unknown:
The nature of abusive tax schemes is both varied and evolving. We
testified last year that as schemes are often hidden, estimates
presented in 2002 of the extent of abusive tax avoidance were inexact
at best. IRS efforts underway to more definitively identify the scope
of the problem revealed that, for the period from October 1, 2001,
until mid-August 2003, 131,000 participants were involved in abusive
schemes. For the 72,600 of these participants identified by February
28, 2003, IRS estimated that about $1.6 billion in taxes were or might
be recaptured, with more to be determined. In addition, on the basis of
the number of promoters identified and the amount of information not
yet received or processed, IRS officials estimated that hundreds of
thousands of other taxpayers were involved in abusive schemes, but they
did not prepare supporting documentation when making the estimate.
According to IRS, recent estimates resulted from knowledge gained over
the last year focusing on more specific information than previously
used.
Abusive Schemes Vary and New Ones Continually Emerge:
Abusive schemes include various kinds of arrangements designed to
circumvent tax laws or evade taxes. As we testified last year, they can
run from very simple to very complex, from clearly illegal to those
carefully constructed to disguise the illegality of the scheme. Users
of schemes can range from those believing their position is correct to
those who knowingly but willfully file incorrect tax returns.
As shown in table 1, SB/SE sorts abusive schemes into seven categories.
They range from trust arrangements to those claiming no legal basis for
federal income taxes to tax shelters bought by taxpayers that are under
SB/SE's auspices. In the case of the latter, SB/SE is responsible for
investigating abusive shelters used by high-wealth individuals with
complex tax returns and by businesses with assets of less than $10
million.
Table 1: Descriptions of Abusive Scheme Categories:
Category of scheme: Abusive trust schemes; Description of the category:
Arrangements featuring layers of trusts, with each trust distributing
income to the next layer to fraudulently reduce taxable income to
nominal amounts.
Category of scheme: Deduction/expense schemes; Description of the
category: False representations of facts to claim improper deductions.
Category of scheme: Refund/credit schemes; Description of the category:
Schemes involving the creation of credits to substantially reduce tax
or create refunds.
Category of scheme: Antitax arguments; Description of the category:
Arguments that entice people to believe collecting federal income taxes
has no legal basis.
Category of scheme: Exempt organization schemes; Description of the
category: Schemes using a tax-exempt entity to obtain unallowable
benefits.
Category of scheme: Tax shelters; Description of the category: Very
complicated transactions that sophisticated tax professionals promote,
exploiting tax loopholes and reaping large and unintended tax benefits.
Category of scheme: Offshore compliance schemes; Description of the
category: Schemes in which the true ownership of income streams and
assets is hidden to improperly shield financial activity from the U.S.
tax system.
Source: IRS data compiled by GAO.
[End of table]
According to IRS officials, the popularity of schemes can also vary.
Officials have seen a decline in slavery reparation schemes over time,
and they have also become aware of new schemes that abuse corporate
"soles" (one-member religious entities used to claim that income is tax
free) and the disabled access credit (used to reduce taxes or create
refunds). One SB/SE official explained that scheme promoters try to
stay in the business of tax avoidance; when one type of scheme is
discovered and addressed, another scheme will take its place.
Scope of Abusive Schemes Is Unknown:
The full scope of the abusive tax scheme problem is unknown because
estimates are difficult to make based on imperfect data. As we
testified last year, estimating the extent of abusive schemes used by
individual taxpayers is at best an inexact process because these
schemes are often hidden.
In fiscal year 2003, SB/SE tried a new approach to improve its
information about the problem and help with its work planning process.
The new approach differed from prior efforts in that it focused on what
IRS had actually found. The effort's aim was to develop an inventory of
abusive schemes and related data in order to develop an overall
strategy for addressing abusive schemes and to enhance the work
planning process. In this context, SB/SE developed a template for
organizing information about known schemes and known investors. The
template took the form of a matrix to be used to compare the risks
presented by various schemes along the lines of factors such as the
number of cases available for IRS staff to review but as yet unstarted,
the number of promoters, the amount of money involved, and the number
of taxpayers participating. The matrix organizes abusive schemes within
the seven categories shown above in table 1.
According to a summary of items in the matrix categories and IRS's work
with offshore credit cards covering October 2001 through mid-August
2003, IRS identified about 131,000 participants in abusive schemes.
This number included 22,000 participants in the offshore credit card
area and, according to SB/SE, reflected the best available data, but
not a potential universe. It updated a previous summary covering
October 1, 2001, through February 2003 that showed 72,600 potential
participants. In that summary, SB/SE noted that recaptured or
potentially recaptured taxes from closed or identified reviews totaled
almost $1.6 billion, excluding undetermined amounts from the credit
card work. That summary also included the 22,000 participants in the
offshore area, but IRS was not able to update this figure for its later
summary because new credit card information had just arrived.
IRS used an estimate in its fiscal year 2005 budget presentation of the
number of taxpayers it believes are involved in abusive schemes who are
likely to be identified through its various efforts. IRS estimated that
more than 400,000 taxpayers fall into this category, generally
including the approximately 131,000 participants it had identified as
of mid-August 2003. According to IRS officials, this estimate was
included in materials provided to the Department of the Treasury and
the Office of Management and Budget during budget discussions. It was
used not as a basis for requesting resources sufficient to examine the
taxpayers, but to show that the abusive scheme problem was large
relative to current resources. According to IRS officials, this
estimate was developed during a series of meetings, but documentation
showing the basis for the estimate was not prepared at that time.
We are unaware of a specific IRS or other policy that requires
contemporaneous documentation of a figure like the 400,000 estimate of
taxpayers IRS expects to identify as engaged in abusive schemes.
Nevertheless, documenting the basis for key numbers related to an
agency's programmatic efforts is in line with the thrust of management
legislation and IRS's own policies. For example, GPRA stresses not only
that agencies develop measures of program performance, but also that
the measures be valid and reliable. IRS too stresses that program
managers have valid and reliable measures of program performance in its
Strategic Planning, Budgeting, and Performance Management Process.
Although the 400,000 estimate is not an IRS program performance
measure, it is a measure that IRS has used in discussions on its fiscal
year 2005 budget needs. Further, Congress has expressed interest in the
specific issue of abusive schemes, including through this review, which
has focused in part on the nature and scope of abusive tax schemes.
Documenting the basis for key program-related numbers ensures that
others can judge their reliability and better understand what may
account for differences in such key numbers over time.
At our request, IRS prepared a document showing how the estimate of
over 400,000 was derived. IRS based this estimate to a great extent on
the promoters it had identified, but for which it had not yet received
investor lists. If each investor list contained only the average number
of names identified on the very few lists considered so far, a
conservative assumption according to SB/SE's Deputy Director,
Compliance Policy, more than 300,000 taxpayers would be involved. In
addition, although IRS had not yet processed most of the offshore
credit card information it had received, staff projected that tens of
thousands of abusive credit card users were likely to be identified.
According to the same official, IRS now believes more taxpayers are
engaged in various abusive schemes not involving offshore credit cards
than it did last year but fewer than it believed last year are engaged
in schemes involving offshore credit cards and likely to be identified.
Not wanting to overstate the total number of taxpayers likely to be
identified as involved in abusive schemes, IRS adopted a conservative
estimate of more than 400,000, emphasizing to us that its program is
still in the developmental stage and the number is probably higher.
Table 2 compares how the 400,000 relates to the numbers used in our
testimony from last year. Because some of the numbers are estimates
based on limited information and because the specific types of cases
included in the different categories are not always identical, the
comparisons are only a general indication of changes in the potential
size of the scheme categories and the total number of taxpayers
involved.
Table 2: Comparison of Different Estimates of the Number of Taxpayers
Involved in Abusive Schemes:
Scheme area[A]: Offshore credit cards and other schemes; February 2002
estimate: 570,000; October 2003 estimate: More than 400,000.
Scheme area[A]: Frivolous returns; February 2002 estimate: 62,000;
October 2003 estimate: 21,000[B].
Scheme area[A]: Frivolous refunds; February 2002 estimate: 105,000;
October 2003 estimate: 127,000[B].
Scheme area[A]: Total; February 2002 estimate: 737,000; October 2003
estimate: More than 548,000.
Source: Derived by GAO from IRS data.
[A] The types of schemes included in the different categories in the
two periods were not consistent, but the differences were small
relative to the total number of taxpayers involved.
[B] These numbers are for fiscal year 2002.
[End of table]
IRS has not associated a dollar amount with its estimate of more than
400,000 taxpayers, although it believes the amount is substantial.
According to SB/SE's Deputy Director, Compliance Policy, IRS is trying
to be more data-driven in this area and is not tracking dollars
associated with its projection.
In addition to the estimate of more than 400,000 taxpayers, some IRS
units collected other information regarding abusive schemes that
identified the scope of other pieces of the problem. These pieces are
not part of SB/SE's examination workload planning effort because they
do not involve examinations. IRS's Frivolous Return Program identifies
returns and refunds for taxpayers whose returns either state an
argument that IRS can readily identify as frivolous or have
characteristics IRS has identified as reflecting a frivolous argument.
The program stopped about 21,000 frivolous returns (as shown in table
2) and refunds resulting in about $619 million in protected tax dollars
in fiscal year 2002. CI identified about 127,000 fraudulent refund
claims in fiscal year 2002 and stopped about $379 million in fraudulent
refunds.
IRS Strategy to Combat Abusive Schemes Is Broad-Based, but Has No Long-
term Performance Goals or Measures Linked to Goals:
IRS's abusive scheme strategy takes a multipart approach to focus
resources on the most egregious promoters of, and participants in,
offshore credit card and other schemes. It entails identifying schemes
and their participants, alerting the public, enforcing the law, and
coordinating efforts internally and throughout IRS. Although IRS
planning documents outline an overall strategy for combating abusive
schemes, IRS has not yet defined long-term performance goals for the
effort and the measures it would use to track progress in achieving
those goals. However, although establishing such goals and measures
will be challenging, IRS intends to establish process and results-
oriented goals in the future.[Footnote 3]
SB/SE's Strategy Includes Pursuing Egregious Promoters As Well As
Offshore Credit Card and Other Abusers:
As outlined in planning documents, the SB/SE strategy to combat abusive
tax schemes focuses on attacking the source of what IRS considers to be
the most egregious abusive noncompliance. The strategy requires using
scarce resources to address three high-priority areas--promoters,
offshore credit card schemes, and other abusive schemes (including
offshore schemes other than credit card schemes)--all under the
jurisdiction of a position established in 2002, the Director of
Reporting Enforcement.
Because promoters generate noncompliance by selling tax avoidance
schemes to others, they represent a top priority in the strategy. By
pursuing promoters, IRS may leverage its resources and gain access to
lists of clients who bought the promoters' products. An SB/SE official
stated that the focus is to pursue promoters first to stop the growth
of abusive schemes. IRS can then take enforcement actions against
participants in abusive schemes.
IRS especially targeted abusive schemes involving credit cards issued
by offshore banks. Credit cards allow easy access to income hidden in
accounts in tax haven countries. In October 2000, IRS issued summonses
to two credit card companies to obtain limited information about U.S.
citizens holding credit cards issued by banks in three offshore
financial centers. After lengthy negotiations to address one of the
company's concerns and reach a compromise for compliance, that company
provided information in April 2002. In March and August 2002, IRS
issued a second round of summonses to credit card companies seeking
records on cards issued by banks in 31 offshore financial centers. The
scope of records to be produced under these summonses had to be
negotiated, with consideration given to the burden of requiring full
compliance, the balance between the amount of information to be
produced and the time needed to produce it, and the need to focus as
much as possible on probable U.S. taxpayers.
Because IRS could not always identify individuals based on credit card
company information, it also issued summonses to 123 merchants for
additional information that could be used in examinations and criminal
investigations. Analyzing merchant responses was very time consuming,
requiring follow-up for more information, and IRS still needed to work
beyond the merchant information provided to identify taxpayers.
On July 30, 2003, IRS announced that as a result of its credit card
project, it had continuing or completed audits on 2,800 returns, and it
had assessed more than $3 million in taxes. As of early August 2003,
IRS had received records from both rounds of credit card company
summonses and from almost all of the merchant summonses. It needed to
go through these records before it would begin to have a better idea of
the size of the credit card problem, keeping in mind that the merchant
summonses related only to merchants identified by analyzing data
produced by one credit card company responding to the first summons.
In January 2003, IRS began a voluntary compliance initiative to
identify promoters and to return to tax law compliance taxpayers who
use offshore payment cards to hide income. Under the initiative,
eligible taxpayers stepping forward before April 16, 2003, would not
pay certain penalties and would not face criminal prosecution, pending
acceptance into the program. However, they would agree to provide full
details on promoters of offshore arrangements. They would also pay
previously owed taxes, interest, and certain other penalties. In
addition to this voluntary compliance initiative and to the summonses,
the Department of the Treasury has entered into tax information
exchange agreements with offshore financial centers to further improve
the federal government's information collection.[Footnote 4]
On July 30, 2003, IRS announced that 1,299 taxpayers stepped forward to
participate in the voluntary compliance initiative, and that analyzing
cases to date revealed 214 new offshore promoters. According to SB/SE's
Deputy Director, Compliance Policy, as of mid-September 2003, the
initiative had led to collecting more than $100 million in tax, a
figure that continues to grow. The 1,299 taxpayers who volunteered is a
small number compared to early reports of the scope of the problem.
However, according to IRS officials, the reality of promoters being
identified by taxpayers gives IRS data on the source of the problem and
a wealth of information that can be used to further investigate abusive
schemes. They said IRS was in the early stages of receiving and
following up on completed packages of information, but it had already
received valuable information on how promoted schemes worked. In
addition, instead of stepping forward, IRS officials say some taxpayers
seem to have filed amended tax returns, bringing themselves into
compliance in a different way. IRS did not yet know the number of
amended returns that arrived as a result of the initiative.
For the abusive schemes shown in table 1, SB/SE's fiscal year 2003
plans called for developing an inventory of schemes and their status,
working out a more detailed overall strategy, and developing and
implementing a process to oversee and manage IRS's efforts to combat
abusive schemes and promoters. In general, SB/SE officials saw fiscal
year 2003 as a transition year in which to build an infrastructure for
full implementation of a strategy in fiscal year 2004. To develop
inventory information, SB/SE has been devising a matrix to assess the
risk associated with various abusive schemes. Although it will not
identify the full scope of the problem, the matrix is intended to help
SB/SE management prioritize the various schemes it encounters and
decide how much in resources to allocate to combat each one.
SB/SE's Strategy Includes Identifying Schemes, Alerting the Public, and
Enforcing the Law:
SB/SE's strategy to combat abusive schemes includes actions to identify
schemes, alert the public, and identify and take enforcement action
against promoters and participants. SB/SE identifies promoters and
participants through disclosure initiatives, Internet research,
investigations, and examinations. IRS is also partnering with state tax
agencies to combat abusive schemes. On September 16, 2003, IRS
announced agreements to, among other things, exchange information about
abusive schemes identified at the federal and state levels, have IRS
provide leads on participants in abusive schemes to states for
investigation, and partner on training and other educational
activities.
SB/SE's strategy to alert the public includes targeting educational
outreach and countermarketing strategies to address abusive schemes and
their promoters. The division's Taxpayer Education and Communication
(TEC) unit, in conjunction with the Communications and Liaison and
Reporting Enforcement units and others, created toolkits for abusive
scheme outreach and education. The toolkits are for external
stakeholders, such as professional organizations, to educate their
members and clients and also for use as internal guidance.
Enforcement action against promoters and participants can take many
forms. For example, IRS criminal investigations can lead to indictments
and convictions. Similarly, IRS conclusions that injunctions are
warranted can lead to promoters being enjoined from continuing with
their promotions. As of May 2, 2003, IRS had 464 ongoing criminal
investigations of scheme promoters and investors, as opposed to 125 in
2001, and 27 promoter injunctions granted, compared to 1 about a year
earlier. IRS can also assert civil penalties or use summonses.
SB/SE's Strategy Is Coordinated within SB/SE and throughout IRS:
Internal coordination is key to SB/SE's approach for addressing abusive
schemes. Last year we testified that SB/SE was reorganizing to place
its key efforts to combat abusive schemes under one executive and
better integrate them. Now SB/SE's Deputy Director, Compliance Policy,
is charged with coordinating the division's strategy for combating
abusive schemes and working closely with other IRS operating divisions.
IRS has also established coordination groups, namely the Abusive Tax
Evasion, Avoidance Schemes, and Devices Executive Steering Committee
and the Offshore Credit Card Project Oversight Board, both of which
include members from different parts of IRS and operate under the
auspices of IRS's Enforcement Committee chartered in July 2003. Chaired
by the Deputy Commissioner for Services and Enforcement, the
Enforcement Committee is to guide IRS-wide enforcement strategies,
focusing on high visibility issues involving many divisions or
potentially having significant compliance impact.
IRS units coordinate with each other in various ways in planning and
implementing actions to combat abusive schemes. For example, in April
2002, SB/SE established the Lead Development Center (LDC) to centralize
the nationwide receipt of leads on promoters of abusive schemes. Once
the LDC organizes promoter information from both agencywide and
external sources, it coordinates with CI to determine who takes the
lead in promoter cases of interest to SB/SE and CI and at times to work
in parallel investigations. Another example of two divisions partnering
with each other was the plan for SB/SE and the Large and Mid-Size
Business Division to jointly find ways to identify entities used to
mask questionable transactions and address their abuse. As part of this
effort, the two divisions planned to develop and implement a strategy
to focus on high-income taxpayers investing in flow-through entities
used to hide taxable income. The planning documents of different IRS
divisions had cross-references to the plans and work of other
divisions.
SB/SE also coordinates internally and with other units in its efforts
to alert the public. TEC and the SB/SE Communications and Liaison unit
coordinate with SB/SE Compliance and with CI and the Office of Chief
Counsel when doing outreach and education. For instance, Counsel
provides legal assistance with language to try to ensure that public
messages are legally accurate. As another example, Communications and
Liaison, Compliance, CI, and Counsel personnel all provided TEC with
input on components of the toolkits TEC developed.
SB/SE Has No Long-term Performance Goals or Measures Linked to Goals:
Although IRS has outlined and begun to implement a strategy for
combating abusive schemes, it has not yet defined performance goals for
the effort and established the measures it would use to track progress
in achieving those goals. Performance goals define what an organization
is trying to achieve over time, preferably focusing on the outcome
desired rather than on activities or outputs. IRS officials recognize
that developing performance goals and associated measures to track
progress is desirable. Although given the substantial difficulty in
assessing the scope of the abusive scheme problem, establishing
performance goals and associated measures will be challenging, IRS
intends to establish process or results-oriented performance goals in
the future.
Using business plans and status reports, SB/SE established some short-
term goals and measures to track its abusive scheme activity. It
established short-term goals, such as developing alternative treatments
and/or a settlement strategy for offshore credit card cases by November
1, 2002. (As mentioned earlier, IRS actually began its offshore
voluntary compliance initiative in January 2003.) SB/SE also used
measures, such as the number of approved investigations. Although
establishing these goals and measures represents progress, IRS has not
developed long-term process and results-oriented performance goals or
measures associated with them.
SB/SE officials acknowledged the importance of goals and measures and
are working on improving. As mentioned earlier, one of SB/SE's fiscal
year 2003 efforts was to develop a detailed overall strategy for
addressing the abusive schemes described in table 1, including a
process to oversee and manage the area. SB/SE officials said they would
devise measures of compliance success once they have their process in
hand and gain experience. Because the extent of abusive scheme activity
is unknown and success in addressing it is hard to define, efforts to
develop long-term performance goals and associated measures are
difficult. However, consistent with their ongoing efforts to build an
infrastructure to address abusive schemes, SB/SE management officials
expressed their intention to establish process and results-oriented
goals and measures in the future. Progress in developing these elements
is crucial to being able to communicate progress made in combating
abusive schemes.
IRS Planned Resource Shifts Are Significant, but Resource Use Started
Slowly and Future Use Remains to Be Seen:
IRS has begun shifting, although more slowly than expected, and plans
to continue shifting, significant resources into addressing abusive
schemes, but the potential volume of additional work that may be
identified and inexperience with the rate at which staff can close
cases make it unclear whether the additional resources and the
caseloads will match each other. At the agencywide level, IRS used a
systematic decision-making process in deciding to make these shifts. At
the SB/SE level, executives considered resources available and program
priorities in significantly increasing SB/SE examination staff
resources devoted to abusive schemes. In doing so, they planned to
shift resources out of examining areas such as small corporations and
nonabusive flow-through entities.
Overall Budget Trade-offs:
IRS decided staffing resource levels to be devoted to addressing
abusive schemes through a systematic planning and budgeting process,
albeit one that used participants' experience and judgment in the
absence of definitive measures of the problem's size. Early in calendar
year 2002, IRS's divisions, including SB/SE, conducted strategic
assessments in which they studied trends, issues, and priorities
affecting their operations. In April 2002, IRS's senior management
team, including the Commissioner, Deputy Commissioner, division heads,
and others, went through two rounds of considering IRS's programs to
prioritize the needs for new or redirected funding for fiscal year
2004. Of 33 programs considered, abusive schemes received the second
most votes. According to an IRS official, this process also informed
how funds already requested for fiscal year 2003 would actually be
spent.
After the senior management team reached consensus, the Commissioner
issued overall planning guidance for fiscal years 2003 and 2004 to
reflect the jointly set strategic direction, and the divisions wrote
fiscal year 2003 and 2004 "strategy and program plans" outlining staff
resources needed. Showing its intent to focus resources on detecting
noncompliance, SB/SE's plan cited an increasing number of abusive
schemes, an abusive scheme estimate of up to $40 billion, promoters
using the Internet as their primary way of operating, and the potential
for abusive schemes eroding taxpayers' confidence in the tax system's
fairness.
SB/SE Used Priorities to Plan for Significant Resource Shift:
For fiscal years 2003 and 2004, SB/SE significantly increased the
examination resources it planned to allocate to new priorities,
including three of its highest: (1) promoters of abusive schemes, (2)
offshore credit card schemes, and (3) other abusive schemes. As shown
in table 3, the planned level of resources for these three areas almost
quadrupled from 267 full-time equivalents (FTE) in fiscal year 2002 to
1,020 FTEs the next year, and it increased slightly from there to 1,154
FTEs for fiscal year 2004.
Table 3: Planned Shift in Revenue Agent and Tax Compliance Officer FTE
Positions Devoted to Abusive Scheme Priority Areas, Fiscal Years 2002-
2004:
Priority area: Promoters of abusive schemes; FY 2002: 16; FY 2003: 150;
FY 2004: 154; Percentage increase from FY 2002 to 2004: 863%.
Priority area: Offshore credit card schemes; FY 2002: 0; FY 2003: 561;
FY 2004: 367; Percentage increase from FY 2002 to 2004: -.
Priority area: Other abusive schemes; FY 2002: 251; FY 2003: 309; FY
2004: 633; Percentage increase from FY 2002 to 2004: 152%.
Priority area: Total; FY 2002: 267; FY 2003: 1,020; FY 2004: 1,154;
Percentage increase from FY 2002 to 2004: 332%.
Source: IRS data compiled by GAO.
Note: These FTEs include revenue agents and tax compliance officers,
but not tax examiners who conduct examinations through correspondence.
Revenue agents and tax compliance officers usually have accounting
experience and meet directly with taxpayers during the audit.
Correspondence examinations do not require tax examiners to meet with
the taxpayer in person.
[End of table]
SB/SE arrived at its fiscal year 2003 budget estimates for different
categories of abusive schemes in different ways. To estimate the number
of examiner FTEs needed for promoters, it started with the number of
approved promoter investigations and assumed another 35 investigations
would be added each month. It also assumed that each investigation
would take 37.5 hours per month for 8 months, for a total of 300 hours.
For offshore credit card schemes, SB/SE estimated a potential number of
participants by extrapolating data from October 2000 summonses to find
potential credit card abusers. It decided how many participants it
could actually examine, which was significantly less than the number of
participants extrapolated, based on the estimated availability of FTEs.
For other abusive schemes, SB/SE estimated a potential number of
participants by using available data on identified schemes and investor
lists. It determined how many hours examining relevant returns would
take by assuming that closing other abusive cases would take certain
percentages of the time needed for nonabusive returns. Although other
abusive schemes evolve and past experience will not necessarily bear
out for the future, for its staff year estimates for other abusive
schemes IRS officials generally had more relevant experience from prior
work on abusive schemes to draw upon than they did for promoter and
offshore credit card staff year estimates.
In determining its budget estimates for all these areas, SB/SE
considered the allocation to other programs. It did this using input
from SB/SE executives and examiners in an iterative process. Given the
shifts to abusive schemes, SB/SE planned to limit the numbers of its
traditional examinations, such as those of small corporations and
nonabusive flow-through entities. For instance, it scheduled the number
of revenue agent FTEs devoted to nonabusive flow-through entities to
decline from 485 to 176 between fiscal years 2002 and 2003, translating
to a decrease in the number of returns examined by revenue agents from
12,318 to 1,078.[Footnote 5] Further, for fiscal year 2003, SB/SE also
began directing its most skilled examination resources away from
national programs, such as claims for refunds and cases with tax
returns identified as being most likely to have their taxes increased
upon audit. To cope with this shift in resources away from certain
areas, IRS planned various mitigating efforts, such as first examining
individuals for abusive schemes and then pinpointing related flow-
through and other entities to be audited, rather than first selecting
the entities to audit. We did not assess how the shifts in resources
would affect examination coverage in the areas losing staff or IRS's
plans to mitigate that effect.
In addition to the increased resources for IRS examination priority
areas reflected in table 3, other parts of SB/SE and IRS also used or
planned to use FTEs to address abusive schemes. For instance, within
SB/SE, although the TEC unit did not specifically allocate FTEs for
abusive schemes in fiscal year 2002, it planned to devote 54 FTEs to
addressing abusive schemes in fiscal year 2003 (about 13 had been used
as of July 26, 2003) and asked for another 125 for fiscal year 2004.
Similarly, the collection function went from 0 FTEs in fiscal year 2002
to planning for 73 and 81 FTEs in fiscal years 2003 and 2004,
respectively. According to an SB/SE official in early August 2003, SB/
SE did not have reliable information on how many FTEs the collection
function had used to date to address abusive schemes in fiscal year
2003.
Outside SB/SE, although CI did not budget staff resources specifically
for abusive schemes, it used 120 FTEs in fiscal year 2002 just on
abusive domestic and foreign trusts and expected significant cascading
effects on its scheme work in the form of referrals from other units.
For fiscal year 2004, it also requested 185 FTEs in addition to the 441
already used to identify, develop, and analyze potentially fraudulent
schemes in its Questionable Refund Program and its Return Preparer
Program. Other SB/SE and IRS areas devoting FTEs to abusive schemes
include the Frivolous Return Program, SB/SE Communications and Liaison,
and the Office of Chief Counsel.
Resource Use Differed from Expectations, and Future Use Remains to Be
Seen:
As of July 31, 2003, IRS had used fewer examination resources combating
abusive schemes than it had expected. Although IRS intends to
significantly shift resources to address abusive schemes, how future
resources will actually be used remains to be seen. The future volume
of cases IRS will need to examine and the rate at which IRS will be
able to close examinations are unclear. Instead of using examination
resources to the extent intended to address abusive schemes, it has
been able to apply them to other high-priority programs, such as its
Unreported Income Discriminant Function effort, and if circumstances
warranted, it could do so again in the future.
As shown in table 4, through July 31, 2003, SB/SE was on track to use
less than half of the 1,020 fiscal year 2003 FTEs designated for
abusive scheme priority areas. It was on track to use 10 percent of the
revenue agent FTEs to be devoted to offshore credit card schemes and 30
percent of those to be devoted to promoters. IRS officials stated that
fiscal year 2003 was a transition year and attributed the slower than
expected start to overly optimistic forecasts for delivering a high
level of workable cases to revenue agents--forecasts made without the
experience needed in the promoter and offshore credit card areas to
gain insight into how slowly or quickly inventory develops. Recent
trends of more cases starting per month indicate that the available
workload is growing.
Table 4: Planned and Projected Revenue Agent and Tax Compliance Officer
FTEs Devoted to Abusive Scheme Priority Areas, Fiscal Year 2003:
Priority area: Promoters of abusive schemes; Planned FTEs: 150;
Projected FTEs if the pace at July 31, 2003 was maintained: 45;
Projected FTEs as a percentage of those planned: 30.
Priority area: Offshore credit card schemes; Planned FTEs: 561;
Projected FTEs if the pace at July 31, 2003 was maintained: 56;
Projected FTEs as a percentage of those planned: 10.
Priority area: Other abusive schemes worked by revenue agents;
Planned FTEs: 275; Projected FTEs if the pace at July 31, 2003 was
maintained: 352; Projected FTEs as a percentage of those planned: 128.
Priority area: Other abusive schemes worked by tax compliance officers;
Planned FTEs: 34; Projected FTEs if the pace at July 31, 2003 was
maintained: 17; Projected FTEs as a percentage of those planned: 51.
Priority area: Total; Planned FTEs: 1,020; Projected FTEs if the
pace at July 31, 2003 was maintained: 470; Projected FTEs as a
percentage of those planned: 46.
Source: IRS data compiled by GAO.
[End of table]
Other data illustrate how difficult it is for IRS to reliably estimate
the resources that may be needed to work abusive schemes due to
uncertainty about the volume of cases that it will need to examine and
the rate at which IRS will be able to close examinations. The data
indicate that, at times, the actual number of cases identified and the
rate at which cases were being closed diverged significantly from the
estimates used to plan for fiscal year 2003 FTEs. For example, as shown
in table 5, by July 31, 2003, SB/SE did not yet have offshore credit
card cases lined up for examination that would approach the number the
budget was intended to cover, and it had closed only 18 percent of the
cases it had anticipated closing. On the other hand, SB/SE had more
cases involving other abusive schemes in its queue for revenue agents
to handle than it had estimated it could work in fiscal year 2003, but
it was closing almost twice as many cases as expected. Having budgeted
FTEs to work 9,060 complete cases involving other abusive schemes, it
had enough resources to begin and/or complete work in fiscal year 2003
on many of the 20,810 cases it identified by July 31, 2003. It could
complete many of the unfinished cases in fiscal year 2004, and by that
time, have identified new cases to work.
Table 5: Comparisons of Inventory Developments with Inventory
Expectations:
Priority area: Promoters; Number of cases identified by July 31,
2003[A]: 535; Number of equivalent cases SB/SE estimated it could
cover in FY 2003: 569; Rate at which cases expected to be closed by
July 31, 2003 actually were closed by that time: Not available.
Priority area: Offshore credit card schemes; Number of cases identified
by July 31, 2003[A]: 2,208[B]; Number of equivalent cases SB/SE
estimated it could cover in FY 2003: 9,455; Rate at which cases
expected to be closed by July 31, 2003 actually were closed by that
time: 18%.
Priority area: Other abusive schemes worked by revenue agents; Number
of cases identified by July 31, 2003[A]: 20,810; Number of equivalent
cases SB/SE estimated it could cover in FY 2003: 9,060; Rate at which
cases expected to be closed by July 31, 2003 actually were closed by
that time: 193%.
Priority area: Other abusive schemes worked by tax compliance officers;
Number of cases identified by July 31, 2003[A]: 2,607; Number of
equivalent cases SB/SE estimated it could cover in FY 2003: 4,570; Rate
at which cases expected to be closed by July 31, 2003 actually were
closed by that time: 44%.
Source: Calculated by GAO from IRS data.
[A] This calculation entailed adding the number of cases that either
started in fiscal year 2003 or were identified to be started but had
not yet begun by July 31, 2003. To this total, we added cases carried
over from fiscal year 2002 into 2003, but adjusted the total to reflect
that a portion of the casework had been completed. For example, if two
cases carried into 2003 were half completed, we counted them as one
case. We relied on IRS estimates of case status to make these
adjustments. The resulting totals do not represent cases that IRS could
necessarily complete in fiscal year 2003 because, we were told, many
cases could take 2 or 3 years.
[B] SB/SE officials explained that over time IRS would identify
additional tax returns related to the 2,208 offshore credit card cases
that had been identified as of July 31, 2003. SB/SE projected that each
offshore credit card case originally identified would eventually
include four tax returns, on average.
[End of table]
SB/SE officials told us that they accommodated shortfalls in cases or
in budgeted examination resources by shifting examination FTEs among
different types of abusive scheme examinations and to other priority
programs. According to them, the offshore credit card cases did not
start as quickly as anticipated because dealing with the summons
process took longer than expected. However, this delay allowed more SB/
SE resources to be used for other abusive schemes.
Although to date SB/SE officials have acted to accommodate unexpected
differences in the volume of cases and the time needed to work them,
uncertainties affecting future resource levels are perhaps even
greater. There is the potential that the volume of cases could grow
significantly, but it is not clear how much the caseload will grow or
how quickly. For example, in the offshore credit card scheme area, IRS
has not yet assessed how many new cases may be identified from the 214
new offshore promoters found in its voluntary compliance initiative
that closed on April 15, 2003. Also, by early August 2003, IRS had
received records from its second round of credit card summonses, which
covered credit card company records on cards issued by banks in 31
offshore financial centers. Efforts like these may potentially expand
the caseload but by an unknown amount.
To the extent the potential cases expand, IRS's experience so far, as
alluded to earlier, has been that it is taking longer than originally
expected to obtain all of the information needed to actually identify
individuals for potential examination and to make informed choices
about which cases merit examination. IRS found, for example, that the
information from credit card summonses often was insufficient to
identify individuals, and, therefore, it had to issue summonses to
merchants as well to obtain identifying information. Therefore, IRS
would be more likely to be able to handle the examination caseload if
the universe of potential examination cases expands, even fairly
significantly, but developing those cases to the point they can
actually be examined stretches out over time, than if a "workable"
caseload materializes quickly.
The fiscal year 2003 statistics in table 5 also illustrate that the
rate at which identified cases may be closed is highly uncertain.
According to an SB/SE official, SB/SE took its time estimates for
working on abusive scheme cases from its most complex abusive case
examinations. SB/SE officials explained that IRS had very little
history to use in estimating the time needed to process promoter,
offshore credit card, and other abusive scheme cases. The matrix being
developed in fiscal year 2003 was designed to collect information that
will help executives assess resources needed. As SB/SE gains experience
with current cases, officials said, the planning process would become
more refined.
Across the spectrum of IRS's responsibilities, IRS works varying
amounts of the identified workload. It has pointed to gaps between what
it should be doing and what it has the capacity to do in areas ranging
from individuals to small and large corporations. IRS will make future
decisions about the portion of abusive scheme cases that it will work
as part of its overall processes for allocating resources among its
many competing priorities.
We have previously raised questions about IRS's ability to shift
compliance resources as planned. We recently testified that many
parties have expressed concern about declining IRS compliance--
especially audit--and collection trends for their potential to
undermine taxpayers' motivation to fulfill their tax
obligations.[Footnote 6] Concerned about these trends, IRS has sought
more resources, including increased staffing for compliance and
collections, since fiscal year 2001. Despite receiving requested budget
increases, staffing levels in key occupations were lower in 2002 than
in 2000. These declines occurred for reasons such as unbudgeted
expenses consuming budget increases and other operational workload
increases.
Conclusions:
Having designated abusive schemes as a priority enforcement area, IRS
has made progress in developing an agencywide effort to address
schemes. To ensure that these efforts are focused and to support both
congressional and IRS assessments of progress in combating abusive
schemes, IRS officials must follow through on their intention to
develop long-term process and results-oriented performance goals and
associated measures.
Fiscal year 2003 experience, however, illustrates that IRS likely will
need to continually adjust its efforts. Although IRS identified many
more of some types of abusive schemes than it expected it could handle
in fiscal year 2003, the development of a workable inventory of
offshore credit card scheme cases progressed much more slowly than
anticipated. On balance, this likely led to IRS using substantially
fewer resources for abusive scheme work in fiscal year 2003 than
anticipated. As with developing long-term goals and measures, officials
recognize that they must build a better analytic basis for judging the
appropriate resources to assign to pursuing abusive schemes and intend
to do so as they better identify the potential workload and how quickly
they can close cases. Given that abusive schemes are a top priority for
IRS and have been the focus of congressional attention, the potential
size of the problem is a key reference point for policymakers in
judging whether IRS has appropriate resources and an effective strategy
over time for combating the schemes. Although estimating the potential
size of the problem is inherently difficult and must rely on
assumptions and officials' judgment, documenting the basis for the
estimates can help others judge how to interpret the numbers and use
them to make decisions.
Recommendation to the Commissioner of Internal Revenue:
We recommend that the Commissioner of Internal Revenue document the
support underlying future IRS estimates of the size of the abusive
scheme problem when IRS prepares the estimates.
Agency Comments:
In written comments, the Commissioner of Internal Revenue agreed with a
draft of this report. He specifically agreed with the recommendation
and said that IRS would establish a methodology for documenting the
basis for the estimates. He noted that the other information we
provided would also help IRS improve its abusive scheme program for
fiscal year 2004 and beyond. In addition, he affirmed IRS's intention
to establish measurable process and results-oriented goals and said
that developing these measures is an operational priority for fiscal
year 2004.
The Commissioner also provided other general comments on our draft
report and an update of activities since the time of our review. For
instance, he said that as a result of LDC improvements, expedited
procedures with the Department of Justice, and many other efforts, IRS
recently identified significant numbers of abusive scheme promoters and
participants and refined its methods to deal with them. In addition, he
noted, a key part of the ongoing, infrastructure-building efforts that
we describe was forming and training 12 cross-functional teams in 2003
to identify traditional or alternative strategies for addressing
individual schemes. Also, he stated that, as of October 2003, 42 states
and the District of Columbia had signed a memorandum of understanding
focusing on exchanging information with IRS relating to abusive tax
avoidance transactions. Finally, he pointed out that given IRS's
inability in 2003 to consistently identify and deliver abusive scheme
cases to be worked in IRS field offices, IRS policy is to focus on
other strategic priorities when it does not have an abusive scheme case
to work.
The full text of the Commissioner's comments is reprinted in appendix
I.
As agreed, unless you publicly announce its contents earlier, we plan
no further distribution of this report until 30 days from the date of
the report. At that time, we will send copies to the Commissioner of
Internal Revenue, the Secretary of the Treasury, and other interested
parties. The report will also be available at no charge on GAO's Web
site at [Hyperlink, http://www.gao.gov] http://www.gao.gov.
If you or your staff have any questions about this report, please
contact Signora May on (404) 679-1920 or me on (202) 512-9110. Melissa
Hinton and Lawrence Korb were key contributors to this report.
Signed by:
Michael Brostek:
Director, Tax Issues:
[End of section]
Appendixes:
Appendix I: Comments from the Internal Revenue Service:
COMMISSIONER:
DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224:
November 12, 2003:
Mr. Michael Brostek:
Director, Tax Issues:
United States General Accounting Office
Washington, D.C. 20548:
Dear Mr. Brostek:
I reviewed your draft report entitled, "Challenges Remain in Combating
Abusive Tax Schemes" (GAO-04-05). We agree with your recommendation
that we need to document the basis for the underlying estimates of the
Abusive Scheme problem and will establish a methodology to do so. The
other information you provided will also help us improve the program
for FY 2004 and beyond. In addition to providing general comments on
your report, we would also like to give you an update on relevant
activities since the date of your audit.
As the report acknowledges, we are making strides in our ability to
identify abusive scheme promoters as well as their participants. Given
the magnitude of the scheme problem today - that there are over 400,000
taxpayers involved and billions of dollars potentially escaping
taxation, we are focused on meeting the challenges raised in your
report. Our Lead Development Center continues to improve its
investigation methods as well as reducing its cycle time for processing
these cases. We have also developed integrated approaches with other
divisions as well as expedited procedures with the Department of
Justice. As a result of these and many other efforts, we have
identified significant numbers of promoters and participants since your
audit, as well as refined our methods to deal with them.
Your report also recognizes our ongoing efforts to build an
infrastructure to address abusive schemes. One key step was the
formation of issue management teams. In 2003, we formed and trained
twelve teams, each headed by an executive or territory manager. These
teams are charged with identifying an overall strategy for their
assigned issue or scheme. Strategies may include traditional approaches
such as examination or alternative resolution strategies which may
resolve large numbers of taxpayer cases more quickly. Team members
include representatives from Small Business/Self-Employed (SB/SE)
Compliance and Taxpayer Education and Communication (TEC) offices and
SBSE Division Counsel. When appropriate, other operating units such as
Large and Mid-Size Business (LMSB), Tax Exempt/Government Entities (TE/
GE) and Criminal Investigation participate.
In September 2003, we announced the establishment of a nationwide
partnership to combat abusive tax avoidance. Under agreements with
individual states, the IRS will share information on abusive tax
avoidance transactions and those taxpayers who participate in them. The
agreements creating this partnership are designed to enable States and
the IRS to move more aggressively in addressing this tax compliance
problem. As of October 2003, 42 states and the District of Columbia
have signed the Memorandum of Understanding focusing on the exchange of
information relating solely to abusive tax avoidance transactions. The
partnership also includes joint public outreach activities to more
effectively counter the claims of those marketing tax schemes and
scams.
As pointed out in your report, we began shifting examination resources
to support our strategic priorities in FY 2003. 2003 was a transition
year, because we did not have an established inventory selection and
delivery system for the new type of work our strategies required. Our
work plan had to rely on limited data given that we had not done this
type of work previously to any great extent. As a consequence we over-
estimated our ability to deliver inventory to the field. While the
total planned Full Time Equivalents for the Abusive Schemes Program
were not delivered, we used the resources for other priority work, such
as the Unreported Income Discriminate Function Program. Given the
inability in 2003 to identify and deliver abusive scheme inventory
consistently, our policy is to focus on other strategic priorities if
we do not have an abusive scheme case to work.
We will establish measurable program goals during Fiscal Year 2004
which will be process and results-oriented. The FY 2004 Business Plan
includes the development of these measures as an operational priority.
We believe we are making progress combating these pervasive attacks
against our tax administration system. We are: (1) better warning
taxpayers about the dangers of the schemes and scams; (2) better
identifying the promoters and participants in them;
(3) using our enforcement powers more effectively; (4) better
coordinating our actions with the Justice Department to shut down the
schemes before they do more damage; (5) bringing taxpayers back into
compliance; and, (6) helping to restore public confidence in the
fairness of our tax administration system.
If you have any questions, please contact me or Joseph R. Brimacombe,
Deputy Director, Compliance Policy, at (202) 283-2200.
Sincerely,
Signed for:
Mark W. Everson:
[End of section]
(450226):
FOOTNOTES
[1] U.S. General Accounting Office, Internal Revenue Service: Enhanced
Efforts to Combat Abusive Tax Schemes--Challenges Remain, GAO-02-618T
(Washington, D.C.: Apr. 11, 2002).
[2] P.L. 103-62.
[3] Guidance related to GPRA can provide a framework in developing
measurable goals and outcome-oriented measures. Although GPRA is
generally applied to agencywide strategic plans, its framework is
useful to guide any type of planning. GPRA requires long-term strategic
and annual performance goals and associated measures, preferring
measures relating to outcomes (results) versus outputs (activities).
Office of Management and Budget guidance says that strategic plans set
out long-term goals, outlining planned accomplishments and their
implementation schedule.
[4] Between November 2001 and November 2002, Treasury entered into
agreements with the Cayman Islands, Antigua and Barbuda, The Bahamas,
the British Virgin Islands, the Netherlands Antilles, Guernsey, the
Isle of Man, and Jersey.
[5] Nonabusive flow-through entities are entities such as trusts and
partnerships that IRS examines as part of its broad coverage of
taxpayers, even though it has no specific reason to think they are
abusive.
[6] U.S. General Accounting Office, Compliance and Collection:
Challenges for IRS in Reversing Trends and Implementing New
Initiatives, GAO-03-732T (Washington, D.C.: May 7, 2003).
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