Tax Shelters
Services Provided by External Auditors Gao ID: GAO-05-171 February 1, 2005Recent legislative and regulatory changes have addressed the relationship between auditor-provided tax services and auditor independence. At this time, the federal regulatory community is exploring further changes. To contribute to the discussion surrounding these changes, GAO's objectives were to determine (1) according to Internal Revenue Service (IRS) data, how many Fortune 500 companies obtained tax shelter services from their auditor; (2) according to IRS data, in how many Fortune 500 companies did the auditor provide the services to individual company officers or directors; and (3) whether selected Fortune 500 case study companies changed how they obtain tax services from their auditor in recent years. For the first two objectives, GAO used IRS and Standard and Poor's data after finding they were sufficiently reliable for our work. GAO counted a company, officer, or director as obtaining a tax shelter service from the company's external auditor when an auditor that IRS identified as promoting a tax shelter also audited the company in at least one year that the shelter was in effect. For the third objective, independent of any IRS information, GAO selected case studies on the basis of geographic location and previous GAO contact. The companies are illustrative in nature and not intended to be representative of other companies.
IRS data available on tax shelter services sometimes predate legislative and regulatory changes reflecting a heightened focus on auditor independence. However, both during this earlier period covered by some of the data and also following the recent changes, auditors were allowed to provide tax services, including tax shelter services, to firms they audited. According to IRS data, 61 Fortune 500 companies obtained tax shelter services from their external auditor during 1998 through 2003 for transactions generally reportable on tax returns sent to IRS. IRS considered some reportable transactions abusive, with tax benefits subject to disallowance under existing law, and other transactions to possibly have some traits of abuse. Estimated multi-year potential tax revenue lost to the federal government from the 61 companies' auditor-related transactions was about $3.4 billion (about $1.8 billion in categories IRS considered abusive). In 17 companies, at least one officer or director used the company's auditor to obtain individual tax shelter services. These numbers are imprecise because they have important limitations. These limitations, such as some transactions in IRS's database without tax shelter providers listed, are fully discussed in this report. Commenting on a draft of this report, IRS said that ongoing changes and recent legislation will enable it to address the data limitations noted. According to their representatives, all eight case study companies adopted or refined policies or practices in 2002 or 2003 for pre-approving tax services or governing the tax services provided, such as who would provide them. All eight reported using their auditor for tax services during 2000 through 2003. Two told us of obtaining tax shelter services from their auditor, but one of them obtained the services before this period. Six of the eight reported officers or directors obtaining individual tax services from the auditor at some time since 2000, with four disallowing the practice later. None reported officers or directors using the auditor for individual tax shelter services.
GAO-05-171, Tax Shelters: Services Provided by External Auditors
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Report to the Ranking Minority Member, Permanent Subcommittee on
Investigations, Committee on Homeland Security and Governmental
Affairs, U.S. Senate:
February 2005:
Tax Shelters:
Services Provided by External Auditors:
GAO-05-171:
GAO Highlights:
Highlights of GAO-05-171, a report to the Ranking Minority Member,
Permanent Subcommittee on Investigations, Committee on Homeland
Security and Governmental Affairs, U.S. Senate:
Why GAO Did This Study:
Recent legislative and regulatory changes have addressed the
relationship between auditor-provided tax services and auditor
independence. At this time, the federal regulatory community is
exploring further changes.
To contribute to the discussion surrounding these changes, GAO‘s
objectives were to determine (1) according to Internal Revenue Service
(IRS) data, how many Fortune 500 companies obtained tax shelter
services from their auditor; (2) according to IRS data, in how many
Fortune 500 companies did the auditor provide the services to
individual company officers or directors; and (3) whether selected
Fortune 500 case study companies changed how they obtain tax services
from their auditor in recent years.
For the first two objectives, GAO used IRS and Standard and Poor‘s data
after finding they were sufficiently reliable for our work. GAO counted
a company, officer, or director as obtaining a tax shelter service from
the company‘s external auditor when an auditor that IRS identified as
promoting a tax shelter also audited the company in at least one year
that the shelter was in effect. For the third objective, independent of
any IRS information, GAO selected case studies on the basis of
geographic location and previous GAO contact. The companies are
illustrative in nature and not intended to be representative of other
companies.
What GAO Found:
IRS data available on tax shelter services sometimes predate
legislative and regulatory changes reflecting a heightened focus on
auditor independence. However, both during this earlier period covered
by some of the data and also following the recent changes, auditors
were allowed to provide tax services, including tax shelter services,
to firms they audited. According to IRS data, 61 Fortune 500 companies
obtained tax shelter services from their external auditor during 1998
through 2003 for transactions generally reportable on tax returns sent
to IRS. IRS considered some reportable transactions abusive, with tax
benefits subject to disallowance under existing law, and other
transactions to possibly have some traits of abuse. Estimated multi-
year potential tax revenue lost to the federal government from the 61
companies‘ auditor-related transactions was about $3.4 billion (about
$1.8 billion in categories IRS considered abusive). In 17 companies, at
least one officer or director used the company‘s auditor to obtain
individual tax shelter services. These numbers are imprecise because
they have important limitations fully discussed in this report, such as
those resulting from some transactions in IRS‘s database not having a
tax shelter provider listed. Commenting on a draft of this report, IRS
said that ongoing changes and recent legislation will enable it to
eliminate the data limitations noted.
According to their representatives, all eight case study companies
adopted or refined policies or practices in 2002 or 2003 for pre-
approving tax services or governing the tax services provided, such as
who would provide them. All eight reported using their auditor for tax
services during 2000 through 2003. Two told us of obtaining tax shelter
services from their auditor, but one of them obtained the services
before this period. Six of the eight reported officers or directors
obtaining individual tax services from the auditor at some time since
2000, with four disallowing the practice later. None reported officers
or directors using the auditor for individual tax shelter services.
Number of Fortune 500 Companies That Obtained Tax Shelter Services from
Their External Auditor and Number with Officers or Directors Who Did
So, 1998 through 2003:
[See PDF for image]
[End of section]
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[End of section]
Contents:
Letter:
Background:
Results in Brief:
Scope and Methodology:
According to Available but Limited Data, 61 Fortune 500 Companies Used
Tax Shelters That Had Been Promoted by Their Auditor:
According to Available but Limited Data, Officers or Directors
Associated with 17 Fortune 500 Companies Used Tax Shelters That Had
Been Promoted by the Company's Auditor:
According to Their Representatives, All Case Study Companies Recently
Changed How They Acquire Tax Services from Their Auditors:
Case Study Companies Said They Paid Auditors Varying Amounts for Tax
Services for Company Officers and Directors:
Agency Comments:
Appendix:
Appendix I: Comments from the Internal Revenue Service:
Tables:
Table 1: Breakdown of the Dates Associated with Officers and Directors
Who Were Listed in S&P Data for 471 Companies:
Table 2: Types of Tax Shelters and Estimated Losses for 61 Fortune 500
Companies That Obtained Tax Shelter Services from Their Auditor for Tax
Years 1998 through 2003:
Table 3: Types of Tax Shelters and Estimated Losses for Various
Categories of Fortune 500 Companies Obtaining Tax Shelter Services:
Table 4: Numbers of Tax Shelter Transactions and Estimated Losses for
Various Categories of Fortune 500 Companies Whose Officers or Directors
Obtained Tax Shelters:
Letter February 1, 2005:
The Honorable Carl Levin:
Ranking Minority Member:
Permanent Subcommittee on Investigations:
Committee on Homeland Security and Governmental Affairs:
United States Senate:
Dear Senator Levin:
Independent public accountants play a critical role in capital and
credit markets by auditing companies' financial statements that
millions of people rely on when investing in the nation's securities
markets. Previous and current auditor independence rules have allowed
accounting firms to provide tax services, including tax shelter
services, to audit clients. However, in May 2003, federal rules began
requiring that clients' audit committees pre-approve the services. Pre-
approval requirements were adopted pursuant to legislation that was
precipitated by various corporate accountability breakdowns.
The Internal Revenue Code has defined tax shelters in various detailed
and complicated ways for purposes of having them registered, for
applying certain penalties, or for certain tax accounting
rules.[Footnote 1] Although IRS has no single, authoritative definition
of abusive shelters, it has generally characterized them as complex
techniques promoted by sophisticated tax professionals that companies
and wealthy individuals use to exploit tax loopholes and reap
unintended tax benefits. Tax services include services involving tax
compliance, tax planning, and tax advice as described by the Securities
and Exchange Commission (SEC).[Footnote 2]
In November 2003, the minority staff of the Permanent Subcommittee on
Investigations reported that selling potentially abusive and illegal
tax shelters was a lucrative business, with some professional firms,
including accounting firms, mass marketing generic tax products to
multiple clients.[Footnote 3] Such generic tax products are potentially
illegal depending on how buyers use them and calculate their tax
liabilities. In October 2003, we testified that Internal Revenue
Service (IRS) data sources, with their various limitations, suggested
that abusive tax shelters totaled tens of billions of dollars of
potential tax losses over about a decade.[Footnote 4] More recently,
the federal regulatory community has proposed more changes relating to
the effect of auditor-provided tax services on auditor independence. In
that context, we are providing information on auditor-provided tax
services, including tax shelter services.
As discussed with your office, our objectives were to obtain
information on both tax shelter services and other tax services
provided by auditors of Fortune 500 companies. Specifically, our
objectives were to determine (1) according to IRS data, how many
Fortune 500 companies obtained tax shelter services from their auditor;
(2) according to IRS data, in how many Fortune 500 companies did the
auditor provide the services to individual company officers or
directors; (3) whether selected Fortune 500 case study companies
changed how they obtain tax services from their auditor in recent
years; and (4) how many of our case study companies provided company
funds to their auditor for tax shelter or other tax services for
company officers or directors, and what the minimum and maximum amounts
of the funds provided were.
To accomplish our first two objectives, we matched data disclosed to or
discovered by IRS on tax shelter acquisitions and promoters of the tax
shelters to information we acquired from Standard and Poor's (S&P) on
the auditors, top officers, and directors of the April 2003 Fortune
500.[Footnote 5] We considered a company, officer, or director as
obtaining tax shelter services from the company's auditor when, for at
least one of the tax years for which the company, officer, or director
received a tax shelter benefit, the company's auditor was identified as
a promoter of the tax shelter by IRS. We used the company's fiscal year
1998 through 2003 auditors for performing our analysis and analyzed
information from other years to provide context.
Although we found the data elements we used from the IRS and S&P
information were sufficiently reliable for the purposes of our work, as
will be described later, the IRS data had important limitations and
should be used with caution. Despite these limitations, the information
in this report provides a general indication of the extent to which
Fortune 500 companies and their officers or directors used their
external auditor for tax shelter services. Our results are imprecise in
reflecting the universe of companies, officers, and directors that
might have obtained tax shelter services from the companies' auditors.
For example, IRS's data may not include all tax shelters because some
taxpayers may not have disclosed all abusive or other reportable
transactions to IRS, and IRS likely has not identified all such
transactions on its own. On the other hand, the data also might include
some tax shelters that could later be determined nonabusive and did
include some items that needed to be reported to IRS but unexpectedly
turned out to be nonabusive. Although not all transactions turned out
to be abusive, we have included in our analysis those transactions that
IRS or taxpayers believed needed to be reported to the federal
government.
To accomplish our last two objectives, independent of any IRS
information, we studied eight Fortune 500 companies that were not
intended to be representative of other companies, and we collected
information from their management and audit committee chairs on tax
services, including tax shelter services, the eight companies obtained.
We chose companies that were geographically diverse and whose audit
committee chair had not been recently contacted for other GAO studies.
We did our work between December 2003 and January 2005 in accordance
with generally accepted government auditing standards. A later section
of this report contains a complete discussion of our scope and
methodology.
Background:
Both SEC and IRS have had an interest in the tax services, particularly
tax shelter services, that accounting firms provide taxpayers. In terms
of SEC, according to the Sarbanes-Oxley Act of 2002,[Footnote 6] before
an SEC registrant company's auditor can provide non-audit services such
as tax services to the company, the company's audit committee must
approve them. Effective May 6, 2003, SEC adopted rules required by the
act to strengthen conflict of interest standards and clarify the
relationship between the independent auditor and the audit committee.
In adopting these rules, SEC said it was enhancing the independence of
accountants that audited financial statements and prepared related
reports to be filed with SEC. It also said that accounting firms could
provide tax services to their audit clients, subject to each client's
audit committee pre-approval, without impairing their independence.
However, accountants would impair their independence if they
represented audit clients before a tax or district court or a federal
court of claims. Further, according to the rules, audit committees
should carefully scrutinize an accountant's involvement in a
transaction if the accountant initially recommended the transaction,
the transaction's sole business purpose might be tax avoidance, and its
tax treatment might not be supported in the Internal Revenue Code and
related regulations.
The Sarbanes-Oxley Act established the Public Company Accounting
Oversight Board (PCAOB) and authorized it to establish standards and
rules for auditor independence. In exercising its responsibilities
under the act, PCAOB determined it was appropriate to consider the
impact on auditor independence of providing tax services to audit
clients. In July 2004, it convened a roundtable discussion on the
effect of tax services provided by auditors on auditor independence.
Participants at the roundtable, including representatives of accounting
firms, public companies, investors, and regulators, discussed many
different topics, with suggestions including more PCAOB guidance to
audit committees and a rule barring auditors from providing at least
some tax services to audit clients.
On December 14, 2004, PCAOB proposed new ethics and independence rules,
with comments due by February 14, 2005, and an effective date of no
earlier than October 20, 2005. The proposed rules would treat an
accounting firm registered with PCAOB as not independent in certain
instances for purposes of doing a financial statement audit and for
other purposes. For example, the firm would be considered not
independent if it provided services related to planning or giving an
opinion on the tax treatment of a listed (described later) or
confidential transaction under Department of the Treasury regulations.
Similarly, the firm would be considered not independent if it provided
these services for a transaction that was based on an aggressive
interpretation of the applicable tax laws and regulations. Such a
transaction is one that satisfies three criteria: it was initially
recommended by a tax advisor; it has tax avoidance as a significant
purpose; and it "is not at least more likely than not to be allowed
under; applicable tax laws."[Footnote 7] The proposal would also treat
the firm as not independent if the firm provided tax services to
officers who oversee an audit client's financial reporting. It would
not prohibit the audit firm from providing the audit client with
routine tax return preparation and tax compliance, general tax planning
and advice, international assignment tax services, and employee
personal tax services. In addition, the proposal would expand on
current SEC pre-approval requirements to require an auditor seeking
audit committee pre-approval of tax services to give the committee
certain information, discuss with the committee the services' potential
effects on the firm's independence, and document the discussion's
substance.
Treasury regulations address IRS's oversight of tax shelters. Under the
regulations,[Footnote 8] there are six categories of transactions for
which investors must report, or disclose, the transactions into which
they have entered, and promoters must maintain lists of investors who
have entered into the transactions.
At IRS, the Office of Tax Shelter Analysis (OTSA) maintains a database
containing information on tax shelter investors and promoters,
including accounting firms.[Footnote 9] Created in February 2000 to
centralize and coordinate IRS's response to abusive tax shelter
activity nationwide, OTSA includes in its database the amount of
potential federal tax loss estimated by the taxpayer or IRS to result
from both listed and nonlisted transactions. These losses, which also
represent benefits to the taxpayer, may or may not be disallowed by IRS
upon further review of each transaction. IRS considers listed
transactions, which must be reported on tax returns sent to IRS, to be
abusive. The Joint Committee on Taxation has described listed
transactions as having a tax avoidance purpose, with the tax benefits
subject to disallowance under existing law.[Footnote 10] For a
transaction to be listed, IRS must issue a notice, regulation, or other
form of published guidance informing taxpayers of the details of the
transaction. In October 2004, IRS had 30 types of listed transactions,
a number that had grown more quickly in recent years than earlier.
Nonlisted transactions generally are transactions reportable to IRS
that may have some characteristics of abusive shelters but are not, and
may never be, listed. At times, IRS questions whether some nonlisted
transactions should be moved into the category of listed transactions.
Results in Brief:
According to available IRS data, for the period from 1998 through 2003,
61 Fortune 500 companies obtained tax shelter services from an
accounting firm that was the company's external auditor for at least
one year that the company received federal tax benefits from the
shelter. These tax shelter transactions were generally reportable on
tax returns sent to IRS. The estimated potential tax revenue loss to
the federal government over many years for these auditor-promoted
transactions used by the 61 companies was about $3.4 billion, with
about $1.8 billion in categories IRS considered to be abusive. More
companies--114--obtained tax shelter services from any accounting firm
and received tax shelter benefits for any year in IRS's database,
including the 61 companies that obtained auditor-related services. By
comparison, a total of 207 Fortune 500 companies obtained tax shelter
services from any type of firm that provided these services--including
the 114 companies that obtained services from accounting firms. The
estimated potential tax revenue loss to the federal government over
many years for these 207 companies was about $56 billion, about 44
percent of it related to tax years 1998 through 2003. The revenue loss
estimates are sometimes from the individual companies and sometimes
from IRS. These numbers are imprecise because they have important
limitations. These limitations, such as some transactions in IRS's
database without tax shelter providers listed, are fully discussed in
this report.
In 17 of the Fortune 500 companies for which we had data on company
officers and directors, at least one officer or director used the
company's auditor to obtain individual tax shelter services for at
least 1 year from 1998 through 2003. By comparison, officers and
directors in more companies--33--used any accounting firm for tax
shelter services. In a total of 57 companies, at least one officer or
director obtained tax shelter services from any type of firm, including
accounting firms and others, providing such services.
Representatives of all eight companies we studied in more depth said
they adopted or refined policies or practices in 2002 or 2003 for pre-
approving tax services or governing the tax services that could be
provided, such as who would provide them. Examples of changes made
include requiring that all engagements with the outside auditor be
subject to approval by the company's audit committee and directing more
work to other tax service providers. All eight companies reported using
their auditor for some tax services during the period from 2000 through
2003. The services ranged from preparing or reviewing company tax
returns to consulting on foreign tax transactions, and the companies
told us that the specific services changed over time. Two of the eight
companies we studied told us of obtaining tax shelter services from
their auditor, but one of them obtained the services before 2000. The
two companies were among three companies that said they did not have a
current policy prohibiting obtaining tax shelter services. None of our
eight case study participants reported officers or directors obtaining
tax shelter services from the auditors, but six of the companies
reported that at some time since 2000 their officers or directors
obtained other tax services from the auditors. In four of these cases,
officials said obtaining such services was later disallowed by the
company.
Officials from four of the eight companies we studied said their
companies paid auditors varying amounts for tax services for company
officers and directors for 2001, and the other four paid nothing. Two
companies indicated one paid about $8,000 and the other about $13,000
for these services. Two other companies did not provide specific
amounts but reported paying more than $0 but less than or equal to $1
million, a category we used in collecting these data.
We are not making any recommendations in this report.
In written comments on a draft of this report, the Commissioner of
Internal Revenue said it was comprehensive and provided an accurate
picture of the factors affecting IRS's ability to have an accurate tax
shelter database. He added that changes IRS was making and recent
legislation will enable IRS to address the data limitations we note in
our report.
Scope and Methodology:
To address our first two objectives--relating to Fortune 500 companies,
officers, and directors obtaining tax shelter services from their
company auditors--we matched data from two sources--S&P and IRS. We
acquired specific S&P data elements for the 497 companies on the April
2003 Fortune 500 list that, according to S&P, either were publicly
owned or had to file with SEC for another reason, such as having
publicly-traded debt. The data elements included the company's employer
identification number, the names of company officers and directors, and
the name of the company's auditor for each year from 1998 through 2003.
The number of Fortune 500 companies for which we actually received S&P
data varied; for instance, we received names of directors and officers
for 471 companies and employer identification numbers for 492.
As shown in table 1, the officers for 441 of the 471 companies were
those listed in the company's proxy statement section on most highly
compensated officers, as filed with SEC for either 2000 or 2002. We
used the years 2000 and 2002 because those were years when the federal
government was significantly enhancing its presence to counter tax
shelter activity that might have been going on for years. Because S&P
did not have similar top officer information for the other companies in
the Fortune 500, or 2000 or 2002 director information for any of them,
it gave us the names reflecting current officers and directors as of
March 2004--the date we obtained the data. Obviously, some of the March
2004 officers for 30 companies and the March 2004 directors for all 471
might have been different from those working in 2000 or 2002, which was
closer to the time when most of the tax benefits related to the
shelters were taken. Consequently, our analysis of the March 2004
information omits any officers and directors who left the relevant
companies after 2002.
Table 1: Breakdown of the Dates Associated with Officers and Directors
Who Were Listed in S&P Data for 471 Companies:
Number of companies: 441;
Dates for officers: 2000 or 2002;
Dates for directors: March 2004.
Number of companies: 30;
Dates for officers: March 2004;
Dates for directors: March 2004.
Source: Information GAO received from S&P.
[End of table]
We matched the S&P data to tax shelter information in IRS's OTSA
database as of May 28, 2004. IRS's database included information
disclosed to or discovered by IRS on companies, individuals, and other
taxpayers who used tax shelters. It also included information on as
many as three entities, including accounting firms, which IRS said
promoted the shelter to the investor. We considered both listed and
nonlisted transactions in the database because from an auditor
independence standpoint, in both cases the promoters were involved with
transactions that IRS or taxpayers believed needed to be reported to
the federal government.
To determine to what extent the 497 companies obtained tax shelter
services, we matched the employer identification numbers in the S&P and
IRS databases. When we found a match, we checked the promoter
information in the IRS database against the audit firm information in
the S&P database to see if the same accounting firm was listed as a
promoter for a particular transaction and as the company's auditor for
one or more years that the shelter benefited the company. Although we
do not know for sure that a company obtained tax shelter and auditing
services from an accounting firm at exactly the same time, we
considered it a match when at least one of the tax years for which the
company received a tax benefit matched a fiscal year from 1998 through
2003 for which the accounting firm was the company's auditor. We did
this because IRS did not have information on exactly when taxpayers
obtained tax shelter services, and 1998 was the year before the
Department of the Treasury reported that the proliferation of corporate
tax shelters was unacceptable.[Footnote 11] We analyzed information
from other years to provide context.
We also matched the names of company officers and directors in the S&P
data to the names of the tax shelter investors in the IRS database.
Whenever we found a match, we tried to verify if the same person was
actually involved, as opposed to two people with the same first and
last names. If the person appeared to be the same (for example, had the
same middle initial), we matched the promoter name for that individual
and, similar to what was just described, the tax benefit dates in the
IRS database to the auditing firm of the individual's company for 1998
through 2003 in the S&P data. Our matching methodology did not allow us
to detect instances in which a spouse or other relative of the officer
or director was the tax shelter investor or instances in which the
investing entity was a partnership or other unit formed by the officer
or director.
As part of our work, we tested the reliability of IRS's database and
the data we received from S&P. For the IRS database, we reviewed
related documentation, interviewed knowledgeable officials, and did
electronic testing. For the information received from S&P, we reviewed
S&P information on its controls over the data and verified sample data
to publicly available documents obtained from SEC's Web site or
elsewhere. For both types of data, we found that the required data
elements were sufficiently reliable for the purposes of our work.
However, as we will describe later, the IRS database had important
limitations and therefore our results are imprecise in reflecting the
universe of companies, officers, and directors that might have obtained
tax shelter services from the companies' auditors.
To deal with our last two objectives--those on case study companies
obtaining tax shelter and other tax services from their auditor and
funding these services for officers and directors--we selected publicly
traded companies among the Fortune 500 to study in depth. Independent
of any IRS information, we reviewed the April 2003 Fortune 500 list and
chose companies that were headquartered in three geographically diverse
parts of the country and whose audit committee chair worked or lived in
one of those areas. We excluded companies whose audit committee chairs
had been contacted in other recent GAO studies.[Footnote 12] Of the 23
companies that met our criteria, 8 agreed to provide information in
response to a structured interview guide we used. For 5 of these 8
companies, we interviewed the audit committee chair. For the other 3,
we relied only on written answers we received from the companies.
Because we studied so few companies and because of the method of
selection, we cannot say that the responses we received represent any
larger group of companies. Further, the companies that we did study
might have agreed to participate because they had special reasons for
wanting to share their tax services experiences with us. Although they
were not representative of change overall, we believe that the 8
companies illustrate some of the changes that have occurred in recent
years related to auditors providing tax services.
We did our work between December 2003 and January 2005 in accordance
with generally accepted government auditing standards.
According to Available but Limited Data, 61 Fortune 500 Companies Used
Tax Shelters That Had Been Promoted by Their Auditor:
As shown in table 2, 61 Fortune 500 companies used a tax shelter that
was promoted by an accounting firm that was their external auditor for
one or more years from 1998 through 2003 in which the company received
benefits from the tax shelter. The 61 companies had 82 transactions
worth about $3.4 billion in estimated potential tax losses over many
years for transactions that were generally reportable on tax returns
sent to IRS. They are out of 492 Fortune 500 companies for which S&P
supplied employer identification numbers and for which we searched for
a match in the May 28, 2004 version of IRS's tax shelter database.
Table 2: Types of Tax Shelters and Estimated Losses for 61 Fortune 500
Companies That Obtained Tax Shelter Services from Their Auditor for Tax
Years 1998 through 2003[A]:
Tax shelter transactions involving the company's auditor for 61 Fortune
500 companies;
Number of tax shelter transactions by IRS category: Listed: 42;
Number of tax shelter transactions by IRS category: Nonlisted: 40;
Number of tax shelter transactions by IRS category: Total: 82;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Listed: $1.8;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Nonlisted: $1.6;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Total: $3.4.
Source: GAO analysis of IRS's May 28, 2004 OTSA database and S&P data.
[A] See text in the next subsection for a discussion of data
limitations that may result in a misstatement of the number of
companies obtaining tax shelter services from their auditors.
[B] The estimated potential tax loss covers a multiyear period and has
important limitations, such as not considering reductions in IRS
estimates that may result from examination, appeal, litigation, or
other sources, and not including potential tax loss estimates for many
transactions.
[End of table]
Table 3 puts this information into various contexts. For instance,
including the 61 companies just described, 67 companies with about $4.1
billion in tax shelter benefits obtained tax shelter services from a
firm that was their auditor sometime, but not necessarily in the same
year the company received some or all the related tax shelter benefits.
We include the 6 additional companies because some analysts have
questioned the propriety of accounting firms promoting tax shelters
even to companies they are not currently auditing. For example, recent
press reports described a company that employed an accounting firm as
its auditor sometime after the year for which the company claimed a tax
shelter benefit from the shelter provided by the accounting firm.
According to the reports, the auditor began auditing financial
statement items resulting from the tax shelter that it had previously
provided, a task the auditor said was within SEC rules.
Table 3: Types of Tax Shelters and Estimated Losses for Various
Categories of Fortune 500 Companies Obtaining Tax Shelter ServicesA:
Tax shelter transactions involving a firm that was the company's
auditor at any time--67 Fortune 500 companies;
Number of tax shelter transactions by IRS category: Listed: 55;
Number of tax shelter transactions by IRS category: Nonlisted: 45;
Number of tax shelter transactions by IRS category: Total: 100;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Listed: $2.4;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Nonlisted: $1.7;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Total: $4.1.
Tax shelter transactions with any accounting firm involvement--114
Fortune 500 companies;
Number of tax shelter transactions by IRS category: Listed: 97;
Number of tax shelter transactions by IRS category: Nonlisted: 99;
Number of tax shelter transactions by IRS category: Total: 196;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Listed: $4.0;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Nonlisted: $4.6;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Total: $8.6.
Tax shelter transactions with any accounting firm involvement--4,383
taxpayers, including individuals;
Number of tax shelter transactions by IRS category: Listed: 4,311;
Number of tax shelter transactions by IRS category: Nonlisted: 761;
Number of tax shelter transactions by IRS category: Total: 5,072;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Listed: $12.3;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Nonlisted: $11.4;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Total: $23.6[C].
Tax shelter transactions of 207 Fortune 500 companies in the database;
Number of tax shelter transactions by IRS category: Listed: 396;
Number of tax shelter transactions by IRS category: Nonlisted: 636;
Number of tax shelter transactions by IRS category: Total: 1,032;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Listed: $16.1;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Nonlisted: $39.5;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Total: $55.6.
Tax shelter transactions of all 10,371 taxpayers, including
individuals, in the database;
Number of tax shelter transactions by IRS category: Listed: 12,261;
Number of tax shelter transactions by IRS category: Nonlisted: 2,779;
Number of tax shelter transactions by IRS category: Total: 15,040;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Listed: $43.0;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Nonlisted: $85.9;
Taxpayer or IRS estimates of potential tax loss (billions)[B]:
Total: $128.9.
Source: GAO analysis of IRS's May 28, 2004 OTSA database and S&P data.
[A] See text in the next subsection for a discussion of data
limitations that may result in a misstatement of the number of
companies obtaining tax shelter services.
[B] The estimated potential tax loss covers a multiyear period and has
important limitations, such as not considering reductions in IRS
estimates that may result from examination, appeal, litigation, or
other sources, and not including potential tax loss estimates for many
transactions.
[C] Total does not equal sum of components due to rounding.
[End of table]
For further context, table 3 shows that including the 67 companies, 114
Fortune 500 companies and almost 4,400 total taxpayers obtained tax
shelter services from accounting firms, including firms they had not
ever used as auditors but might one day. The estimated potential tax
losses involved were about $9 billion for the 114 companies for any
year in IRS's database and about $24 billion for all
taxpayers.[Footnote 13] Although we did not have enough information to
know whether taxpayers obtained fewer tax shelter services from
accounting firms as time went on, several accounting firms testified in
November 2003 before the Permanent Subcommittee on Investigations of
the Senate Committee on Governmental Affairs that they had scaled back
their tax shelter activities in general.
Including the 114 companies, 207 Fortune 500 companies, regardless of
who their promoters were, used tax shelters accounting for about $56
billion in estimated potential tax losses, about 44 percent of it
related to tax years 1998 through 2003. To break out the $56 billion
further, of the 492 Fortune 500 companies for whom S&P supplied
employer identification numbers, 139 appeared in IRS's database to have
engaged in listed transactions with estimated potential tax losses of
about $16 billion. The number of companies engaged in nonlisted
transactions estimated to be potentially worth about $40 billion was
129, and because some companies were involved in both kinds of
transactions, the number engaged in either listed or nonlisted
transactions was 207.
The 207 Fortune 500 companies' transactions are part of IRS's total tax
shelter database. As of May 28, 2004, for all taxpayers, the database
contained listed and nonlisted transactions with estimated potential
tax losses of about $129 billion, about half of it related to tax years
1998 through 2003. Most of the dollar amounts related to nonlisted, as
opposed to listed, transactions, and some of the amounts shown as
listed might represent transactions that taxpayers entered into before
IRS had designated them as listed. About a third of the approximately
15,000 transactions in the database had an accounting firm listed as a
promoter, and these transactions accounted for about 18 percent of the
$129 billion estimated potential tax loss.
IRS Database Limitations:
We and IRS know the numbers in this section are not precise. Some of
the imprecision could make the count of transactions and associated
estimated potential losses too high, and some could make them too low.
Accordingly, the numbers should be used with caution and should be
understood and used as general estimates of the degree to which
companies might have obtained tax shelter services from external
auditors and of the possible dollar magnitude of the associated tax
benefits, and thus possible decreased federal revenues.
The numbers could be overestimates for the following reasons:
* The number of abusive transactions and their dollar amounts might
have been or might still be reduced upon further examination, appeal,
litigation, or other action.
* The database included some reported transactions that turned out to
be nonabusive. Additional transactions might later be found to be
nonabusive.
* According to an IRS official, the database included some tax shelter
transactions more than once--at the level of a flow-through entity,
such as a partnership, and again at the level of the taxpayers, for
example, the individual partners--with the relevant dollar amounts thus
appearing twice. This limitation would not apply to information dealing
only with Fortune 500 companies' use of tax shelters.
The numbers could be underestimates for the following reasons:
* The IRS database did not include promoters for about a quarter of the
transactions of the 207 Fortune 500 companies that used tax shelters.
In these cases, the tax shelter might have been obtained using a
promoter that the taxpayer did not identify to IRS, or, according to an
IRS official, a very few taxpayers not working for firms designing tax
shelters might have developed their own tax shelter. In total, the
database did not include promoters for 2,095, or about 14 percent, of
its transactions as of May 28, 2004.
* The database did not reflect estimated potential tax losses for about
a third of the transactions of the Fortune 500 companies using an
accounting firm to obtain tax shelters, or for about a quarter of the
transactions of the total number of Fortune 500 companies obtaining tax
shelters. According to an IRS official, this was because taxpayers did
not include estimated losses on documents submitted to IRS. The
official added that a possible reason for taxpayers not disclosing such
information was that nondisclosure penalties did not yet
exist.[Footnote 14] The database did not reflect estimated potential
tax losses for about two-thirds of the 15,040 total transactions it
contained. These potential losses could range from small to large
amounts; however, their distribution is unknown.
* In addition, as of May 28, 2004, IRS had not yet entered into the
database all of the tax shelter information that it possessed even
though the information included data pertaining to transactions done
years ago.
* The database only included information on abusive or possibly abusive
transactions that had been disclosed to or discovered by IRS, and as
alluded to earlier, the number of listed transactions had continually
grown from even before OTSA was established.
Adding to the uncertainty, the tax loss estimates in the database vary
from being IRS officials' recommended taxes, based on examining some
transactions, to taxpayer judgments regarding potential losses in cases
where examinations had not been done. According to an IRS official,
taxpayer-provided information may represent estimates or incomplete
information.
Despite these data limitations, the numbers we present in this report
provide a general indication of the extent to which Fortune 500
companies did use their external auditor for tax shelter services. In
addition, they include larger numbers showing that many Fortune 500 and
other taxpayers obtained tax shelter services using their own and other
accounting firms, and many obtained tax shelters without using
accounting firms at all.
According to Available but Limited Data, Officers or Directors
Associated with 17 Fortune 500 Companies Used Tax Shelters That Had
Been Promoted by the Company's Auditor:
As shown in table 4, one or more officers or directors of 17 Fortune
500 companies used tax shelters that were promoted by an accounting
firm that was the Fortune 500 company's external auditor during at
least one of the years that the officer or director benefited from the
tax shelter. The years in question were 1998 through 2003, and the
potential tax loss from these transactions was about $100 million. The
officers or directors are from 471 Fortune 500 companies for which we
had data on officers or directors from S&P that we matched against data
in the May 28, 2004 version of IRS's tax shelter database.
Table 4: Numbers of Tax Shelter Transactions and Estimated Losses for
Various Categories of Fortune 500 Companies Whose Officers or Directors
Obtained Tax SheltersA:
Tax shelter transactions of officers and directors involving the
company's auditor--17 Fortune 500 companies;
Number of tax shelter transactions: 33;
Taxpayer or IRS estimates of potential tax loss (billions)[B]: $0.1.
Tax shelter transactions of officers and directors involving any
accounting firm--33 Fortune 500 companies;
Number of tax shelter transactions: 53;
Taxpayer or IRS estimates of potential tax loss (billions)[B]: $0.3.
All tax shelter transactions of officers and directors--57 Fortune 500
companies;
Number of tax shelter transactions: 87;
Taxpayer or IRS estimates of potential tax loss (billions)[B]: $1.0.
Source: GAO analysis of IRS's May 28, 2004 OTSA database and S&P data.
[A] See the accompanying text for a discussion of data limitations that
may result in a misstatement of the number of companies whose officers
or directors obtained tax shelter services.
[B] The estimated potential tax loss covers a multiyear period and has
important limitations, such as not considering reductions in IRS
estimates that may result from examination, appeal, litigation, or
other sources, and not including potential tax loss estimates for many
transactions.
[End of table]
To place the officers and directors of the 17 companies into context,
in 33 companies, a transaction of at least one officer or director had
an accounting firm listed as a promoter,[Footnote 15] and in 57 of
them, at least one officer or director obtained a tax shelter
regardless of whom he or she used as a promoter. The number of officers
and directors involved in even the 57 companies translated to less than
one percent of the officers and directors of Fortune 500 companies that
we matched against IRS's database.
These numbers relating to officers and directors of Fortune 500
companies are subject to the limitations described previously for the
numbers related to the companies themselves. For example, IRS's
database did not list promoters or estimated potential tax losses for
every transaction. In addition, according to an IRS official,
disclosures from individuals, partnerships, and S corporations, which
were first due to IRS for filing year 2003, arrived in great numbers
beginning in April 2004, and many were not yet entered into the IRS
database as of May 28, 2004.
According to Their Representatives, All Case Study Companies Recently
Changed How They Acquire Tax Services from Their Auditors:
According to their representatives, all eight of our case study
companies adopted or refined policies or practices in 2002 or 2003
requiring their audit committees to pre-approve tax services to be
obtained or governing the tax services provided. At least some of these
changes were in response to the Sarbanes-Oxley Act. Examples of changes
made include requiring that all engagements with the external auditor
be subject to approval and directing more work to other providers. As
stated earlier, these companies are not representative of other
companies because of their small number, the way we selected them, and
their unknown motivation for participating with us. However, they do
illustrate that the provision of tax services has changed in recent
years for at least some companies.
According to company representatives, all eight case study companies
obtained tax services from their auditors during the period from 2000
through 2003.[Footnote 16] Services provided ranged from company to
company, sometimes involving, for instance, tax return preparation, tax
return review, advice on foreign tax transactions, or consultations on
negotiations. Only two of the companies told us of obtaining tax
shelter services, and one of them obtained the services before 2000.
Company representatives told us about how specific services the company
acquired changed over time. In fiscal year 2004, one company's audit
committee rejected auditor involvement in a particular tax strategy out
of concern that the auditor could potentially be in the position of
auditing its own work. Another company told us of discontinuing an
arrangement for obtaining certain tax services from its auditor because
of the arrangement's undesirable appearance. A third company told us of
transferring some tax services from its auditor to other providers in
2003 and 2004 because the audit committee began requiring a compelling
reason to use its auditor for the services. In spite of these changes,
in stating general impressions, six case study companies said that
having their audit firm provide tax services brought efficiency and
effectiveness gains due to the firm's understanding of the company and
its business.
The two case study companies that obtained tax shelter services in the
past were among the three companies of the eight that said they did not
have a current policy prohibiting obtaining tax shelter services.
However, one of the two companies said that it did not plan to obtain
tax shelters in the future. According to both companies, IRS challenged
the tax shelter claimed, and the issue had not yet been resolved.
Six of Eight Case Study Companies Said They Allowed Officers and
Directors to Obtain Tax Services from the External Auditor, but Four
Said They Then Stopped:
Although six of our case study companies reported that officers or
directors at some time since 2000 used the auditor for some tax
services, such as tax return preparation, officials told us that four
of the companies in 2002 or 2003 adopted policies prohibiting officers
from using the auditor for the services in the future. One company
cited auditor independence reasons for removing as of 2003 its
requirement that a particular executive use the company's auditor. In
contrast to the situation with tax services in general, none of the
companies reported officers or directors obtaining tax shelter services
from the company auditor.
Three companies we contacted said they did not have a policy
prohibiting officers from obtaining tax services from the company
auditor. However, even among those, one company knew of no officers who
had actually used the auditor from 2000 onward for tax services.
Another company allowed using the auditor but annually surveyed its
senior officers about perceived or actual conflicts of interest. The
third said its executives could use the auditor but had done so only in
limited instances.
Case Study Companies Said They Paid Auditors Varying Amounts for Tax
Services for Company Officers and Directors:
For the year we asked about in which officers or directors were still
using the company auditor for tax services--2001--two case study
companies that paid for these services indicated one paid the auditor
about $8,000 and the other about $13,000. Although two other companies
reported paying for these services, they did not provide us with
specific amounts. Both fell into the lowest non-zero choice of range we
provided--greater than $0 but less than or equal to $1
million.[Footnote 17] The other four of the eight companies we studied
reported paying their auditors nothing in 2001 for tax services for
officers or directors.[Footnote 18]
In general and not restricted to 2001, five case study companies
reported setting aside funds for, or annually paying for, tax services
that officers or directors obtain from their auditors or others. In
those cases, company figures varied from a range of $30,000 to $50,000
in one case to $150,000 in another.
Agency Comments:
In written comments on a draft of this report, the Commissioner of
Internal Revenue said it was comprehensive and provided an accurate
picture of the factors affecting IRS's ability to have an accurate tax
shelter database. He particularly pointed to indications in the draft
report that not all the information in the database might relate to
abusive tax avoidance transactions.
The Commissioner also said that IRS changes and recent legislation will
enable IRS to address the database limitations we note, several of
which IRS had already identified and was working to overcome. He added
that IRS was creating a new database and exploring considering whether
various IRS forms should be revised to improve the quality of
information IRS receives. In addition, he noted that IRS supported the
December 2004 PCAOB action to revise auditor ethics and independence
rules.
The full text of the Commissioner's comments is reprinted in appendix
I.
As discussed with your staff, 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
Chairmen and Ranking Minority Members of the Senate Committee on
Finance and the House Committee on Ways and Means, the Commissioner of
Internal Revenue, and other interested parties. The report will also be
available at no charge on GAO's Web site at [Hyperlink,
http://www.gao.gov].
If you or your staff have any questions about this report, please
contact me at (202) 512-9110 or at [Hyperlink, brostekm@gao.gov] or
Signora May at (404) 679-1920 or at [Hyperlink, maysj1@gao.gov].
Jeffrey Arkin, Lawrence Korb, MacDonald Phillips, Tina Smith, James
Ungvarsky, and Walter Vance were key contributors to this report.
Sincerely yours,
Signed by:
Michael Brostek:
Director, Tax Issues:
[End of section]
Appendixes:
Appendix I: Comments from the Internal Revenue Service:
DEPARTMENT OF THE TREASURY:
INTERNAL REVENUE SERVICE:
COMMISSIONER:
WASHINGTON, D.C. 20224:
January 19, 2005:
Mr. Michael Brostek:
Director, Tax Issues:
United States Government Accountability Office:
Washington, D.C. 20548:
Dear Mr. Brostek:
Thank you for giving us the opportunity to review and comment on your
draft audit report titled, "Tax Shelters: Services Provided by External
Auditors" (GAO-05-171). The report is comprehensive and although it
does not contain any audit recommendations, it provides an accurate
picture of the factors that have impacted the Internal Revenue
Service's ability to accurately populate the Tax Shelter Database. We
appreciate your efforts to fully describe the tax shelter information
in this database and the fact that not all the information reported
might relate to abusive tax avoidance transactions.
The Commissioner, Large and Mid-Size Business Division had already
identified several of the limitations you describe in the report, and
is working to develop and implement a plan to overcome them. This
includes the creation of a new database underway that would allow
faster and more accurate population of the database. It also includes
recommendations for a number of revisions to Form 8886, Reportable
Transaction Disclosure Statement; Form 8264, Application for
Registration of a Tax Shelter; and Form 8271, Investor Reporting of Tax
Shelter Registration Number, to refine and enhance the quality of the
information we currently receive. These changes together with the new
tax shelter provisions of the American Jobs Creation Act of 2004 will
enable us to address the limitations you noted in your report.
If you have any questions, please call me or Kathy Petronchak, Director
of Pre-Filing and Technical Guidance within the LMSB Division at (202)
283-8463.
Sincerely,
Signed by:
Mark W. Everson:
[Handwritten Note]: Mike - We support the December, 2004 action of
PCAOB on this problem!
[End of section]
(450283):
FOOTNOTES
[1] 26 U.S.C. sections 6111, 6662, and 461.
[2] Tax compliance generally involves tax return preparation, claims
for refund, and tax payment-planning services. Tax planning and tax
advice include such things as helping with tax audits and appeals and
dealing with mergers and acquisitions and rulings or technical advice
from taxing authorities. See SEC, Final Rule: Strengthening the
Commission's Requirements Regarding Auditor Independence, Release No.
33-8183 (Washington, D.C.: Jan. 28, 2003).
[3] Minority staff of the Permanent Subcommittee on Investigations,
U.S. Senate Committee on Governmental Affairs, U.S. Tax Shelter
Industry: The Role of Accountants, Lawyers, and Financial Professionals
(Washington, D.C.: November 2003).
[4] GAO, Internal Revenue Service: Challenges Remain in Combating
Abusive Tax Shelters, GAO-04-104T (Washington, D.C.: Oct. 21, 2003).
[5] The Fortune 500, published annually by Fortune magazine, consists
of the 500 largest U.S. corporations, in terms of revenue, that publish
financial data and must report part or all of their figures to a
government agency. The April 2003 list that we used ranked companies
according to their 2002 revenues.
[6] Pub. L. No. 107-204, July 30, 2002.
[7] Public Company Accounting Oversight Board, PCAOB Release No. 2004-
015 (Washington, D.C.: Dec. 14, 2004.)
[8] Treas. Reg. Sec. 301.6112-1 and Treas. Reg. Sec. 1.6011-4.
[9] According to an IRS official and IRS Form 8886, the database
includes as a promoter a person, including an entity such as an
accounting firm, that received a fee with regard to a transaction if
that person promoted, solicited, or recommended a taxpayer's
participation in the transaction, or provided tax advice related to the
transaction.
[10] Joint Committee on Taxation, Background and Present Law Relating
to Tax Shelters, JCX-19-02 (Washington, D.C.: Mar. 19, 2002).
[11] Department of the Treasury, The Problem of Corporate Tax Shelters
(Washington, D.C.: July 1999).
[12] GAO, Public Accounting Firms: Mandated Study on Consolidation and
Competition, GAO-03-864 (Washington, D.C.: July 30, 2003) and GAO,
Public Accounting Firms: Required Study on the Potential Effects of
Mandatory Audit Firm Rotation, GAO-04-216 (Washington, D.C.: Nov. 21,
2003).
[13] The tax losses estimated by taxpayers and IRS and contained in
IRS's OTSA database cover a wide range of years from at least as far
back as tax year 1989 and extending even to future tax years since, for
instance, improperly claimed deductions may be used in some cases to
reduce future taxes.
[14] The American Jobs Creation Act of 2004, Pub. L. No. 108-357, Oct.
22, 2004, created such penalties.
[15] The fact that the IRS database shows about 4,400 taxpayers
obtaining tax shelter services from an accounting firm shows that many
of the taxpayers using accounting firms for tax shelter work were
neither Fortune 500 companies nor their officers or directors.
[16] In 2003, a GAO report included information from which we
calculated that 82 percent, or 130 of 159, respondents to an
unprojected GAO survey of Fortune 1000 companies received tax-related
services, such as tax preparation, from their auditor. See GAO,
Accounting Firm Consolidation: Selected Large Public Company Views on
Audit Fees, Quality, Independence, and Choice, GAO-03-1158 (Washington,
D.C.: Sept. 30, 2003). Similarly, in 2004, Glass, Lewis & Co. included
information from which we calculated that about 95 percent of the
approximately 460 Fortune 500 companies it reviewed paid tax fees to
their auditors in 2003. See Glass, Lewis & Co., LLC, Auditor Fees: The
Price of an Independent, Quality Audit (2004).
[17] We used this broad a range in light of press reports showing fees
of $1 million and more.
[18] 2001 was the last year for which publicly held companies did not
have to report to SEC the amounts of tax fees paid to the company
auditor for all tax services, including any for officers or directors.
For fiscal years ending after December 15, 2003, companies for the
first time had to publicly disclose these tax fees, and they had to do
it for the last 2 fiscal years. According to these reported amounts,
for five of the eight case study companies, 2003 tax fees were lower
than 2002 tax fees. Reasons given to us for the decline in individual
company tax fees included a large number of tax-related transactions in
2002 and the need to spend more money in 2002 to deal with an IRS audit
and to use auditor software.
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