Tax Administration
Additional Time Needed to Complete Offshore Tax Evasion Examinations Gao ID: GAO-07-237 March 30, 2007Much offshore financial activity is not illegal, but numerous illegal offshore schemes have been devised to hide or disguise the true ownership of income streams and assets. IRS studies show lengthy development times for some offshore cases, which suggests that time or the lack thereof could be an impediment to effectively addressing offshore schemes. GAO was asked to (1) compare offshore and nonoffshore examination cases and determine whether the 3-year statute of limitations reduces offshore assessments, (2) compare enforcement problems posed by offshore cases to those where Congress has previously granted an exception to the statute, and (3) identify possible advantages and disadvantages of an exception to the statute for offshore cases. To address these objectives, GAO analyzed IRS data, reviewed examination files and other documents, and interviewed IRS officials and others in the tax practitioner and policy communities.
Examinations involving offshore tax evasion take much more time to develop and complete than other examinations for reasons such as technical complexity and the difficulty of obtaining information from foreign sources. When examinations are completed, the resulting median assessment from an offshore examination is almost three times larger than from other types of examinations. However, due to the 3-year statute, the additional time needed to complete an offshore examination means that IRS sometimes has to prematurely end offshore examinations and sometimes chooses not to open one at all, despite evidence of likely noncompliance. Although data were not available to measure the effect of the statute on assessments, IRS agents and managers told GAO that overall assessments for offshore cases are lower than they would be if IRS had more time to work these cases. Some offshore examinations exhibit enforcement problems similar to those where Congress has granted a statute change or exception in the past. For example, Congress changed the statute for certain abusive tax shelters that involved technical complexity and dilatory tactics on the part of taxpayers. Through discussions with IRS officials and others in the tax practitioner and policy communities, GAO identified advantages and disadvantages to such an exception. Advantages included increased flexibility for IRS to direct enforcement resources to egregious cases of noncompliance and a possible deterrent to future noncompliance. Disadvantages included increased uncertainty and lack of closure for taxpayers. Our commenters also discussed design options to mitigate some of the disadvantages of a statute extension, such as making an exception apply to all taxpayers having offshore accounts/entities, and thereby, mitigating taxpayer uncertainty and lack of closure.
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-07-237, Tax Administration: Additional Time Needed to Complete Offshore Tax Evasion Examinations
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Report to the Committee on Finance, U.S. Senate:
United States Government Accountability Office:
GAO:
March 2007:
Tax Administration:
Additional Time Needed to Complete Offshore Tax Evasion Examinations:
GAO-07-237:
GAO Highlights:
Highlights of GAO-07-237, a report to the Committee on Finance, U.S.
Senate
Why GAO Did This Study:
Much offshore financial activity is not illegal, but numerous illegal
offshore schemes have been devised to hide or disguise the true
ownership of income streams and assets. IRS studies show lengthy
development times for some offshore cases, which suggests that time or
the lack thereof could be an impediment to effectively addressing
offshore schemes.
GAO was asked to (1) compare offshore and nonoffshore examination cases
and determine whether the 3-year statute of limitations reduces
offshore assessments, (2) compare enforcement problems posed by
offshore cases to those where Congress has previously granted an
exception to the statute, and (3) identify possible advantages and
disadvantages of an exception to the statute for offshore cases. To
address these objectives, GAO analyzed IRS data, reviewed examination
files and other documents, and interviewed IRS officials and others in
the tax practitioner and policy communities.
What GAO Found:
Examinations involving offshore tax evasion take much more time to
develop and complete than other examinations for reasons such as
technical complexity and the difficulty of obtaining information from
foreign sources. When examinations are completed, the resulting median
assessment from an offshore examination is almost three times larger
than from other types of examinations. However, due to the 3-year
statute, the additional time needed to complete an offshore examination
means that IRS sometimes has to prematurely end offshore examinations
and sometimes chooses not to open one at all, despite evidence of
likely noncompliance. Although data were not available to measure the
effect of the statute on assessments, IRS agents and managers told GAO
that overall assessments for offshore cases are lower than they would
be if IRS had more time to work these cases.
Figure: Median Assessment Amount by Number of Examination Days,
Examinations Closed with an Assessment, Fiscal Years 2002-2005:
[See PDF for Image]
Source: GAO analysis of IRS data.
[End of figure]
Some offshore examinations exhibit enforcement problems similar to
those where Congress has granted a statute change or exception in the
past. For example, Congress changed the statute for certain abusive tax
shelters that involved technical complexity and dilatory tactics on the
part of taxpayers.
Through discussions with IRS officials and others in the tax
practitioner and policy communities, GAO identified advantages and
disadvantages to such an exception. Advantages included increased
flexibility for IRS to direct enforcement resources to egregious cases
of noncompliance and a possible deterrent to future noncompliance.
Disadvantages included increased uncertainty and lack of closure for
taxpayers. Our commenters also discussed design options to mitigate
some of the disadvantages of a statute extension, such as making an
exception apply to all taxpayers having offshore accounts/entities, and
thereby, mitigating taxpayer uncertainty and lack of closure.
What GAO Recommends:
To provide IRS with additional flexibility in combating offshore
schemes, Congress should consider a longer statute period for taxpayers
involved in offshore activity. In e-mailed comments on a draft of this
report, IRS expressed agreement that a longer statute makes sense and
should enhance compliance.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-237].
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:
Offshore Examinations Take Longer Than Other Examinations, so the 3-
Year Statute Can Lead to Lower Assessments Than Would Otherwise Be
Possible:
Some Offshore Examinations Present Enforcement Problems Similar to
Those Where Congress Granted Changes to the Statute:
Changing the Statute Would Necessitate Weighing Advantages and
Disadvantages:
Conclusions:
Matter for Congressional Consideration:
Agency Comments and Our Evaluation:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Median Development Days by Examination Type, Fiscal Years 2002-
2005:
Table 2: Median Examination Days by Examination Type, Fiscal Years 2002-
2005:
Table 3: Median Total Cycle Time by Case Type, Fiscal Years 2002-2005:
Table 4: Median Assessments by Examination Type, Fiscal Years 2002-
2005:
Table 5: Assessment Dollars per Examination Hour by Examination Type,
Fiscal Years 2002-2005:
Table 6: Disposition of Cases When a Disciplinary Action Stemming from
a Barred Statute Was Initially Recommended, Fiscal Years 2005-2006:
Table 7: Views of Interested Parties in General on Changing the Statute
for Offshore Examinations:
Table 8: Views of Interested Parties on Design Options for Changing the
Statute for Offshore Examinations:
Figures:
Figure 1: Notional Representation of IRS Audit Selection Process:
Figure 2: Median Assessment Amount by Number of Examination Days, All
Examinations Closed with an Assessment, Fiscal Years 2002-2005:
Figure 3: Median Assessment Amount by Number of Examination Days, Field
Examinations Closed with an Assessment, Fiscal Years 2002-2005:
Abbreviations:
AIMS: Audit Information Management System:
ATS: abusive tax shelter:
FTB: California Franchise Tax Board:
IBC: international business corporation:
IRC: Internal Revenue Code:
IRS: Internal Revenue Service:
LAO: California Legislative Analyst's Office:
LDC: Lead Development Center:
LLC: limited liability corporations:
LLP: limited liability partnership:
SB/SEIRS: Small Business/Self Employed division:
TIGTA: Treasury Inspector General for Tax Administration:
United States Government Accountability Office:
Washington, DC 20548:
March 30, 2007:
The Honorable Max Baucus:
Chairman:
Committee on Finance:
United States Senate:
The Honorable Charles E. Grassley:
Ranking Member:
Committee on Finance:
United States Senate:
In recent years, the Internal Revenue Service (IRS) has observed a
significant increase in offshore activity among U.S. taxpayers. More
and more taxpayers have been observed attempting to "expatriate" their
income and assets. Making investments or doing business internationally
is legal, but numerous schemes have been devised in which the true
ownership of income streams and assets has been hidden or disguised
using offshore activity, which is not legal. Some schemes can be as
simple as taking unreported income and personally traveling to a tax
haven country and depositing the cash into a bank account. Other
schemes are more elaborate, involving numerous domestic and foreign
trusts, partnerships, nominees, foreign financial accounts, offshore
credit/debit cards, and multilayered transactions. Like all forms of
noncompliance, offshore schemes add to the tax gap--the difference
between taxes owed and taxes paid on time--and shifts more of the tax
burden onto compliant taxpayers. Such schemes also can fuel a
perception that the tax system is not equitable and can erode honest
taxpayers' faith in the voluntary compliance system. When IRS discovers
an offshore scheme, it has 3 years from when the tax return was filed
in which to work on uncovering the scheme and assessing any additional
tax. This is known as the 3-year statute of limitations on assessments.
In recognizing the serious problem posed by offshore tax evasion, you
asked us to identify any impediments that may exist to better combating
these schemes. An IRS study shows lengthy examination times for some
offshore examinations, which suggests that time or the lack thereof
could be an impediment to effectively addressing offshore schemes. This
report focuses on this possible impediment. Our objectives were to (1)
compare the length of and recommended assessments yielded by offshore
and nonoffshore examinations and determine whether the 3-year statute
of limitations reduces recommended offshore assessments, (2) determine
whether or not enforcement problems posed by offshore examinations are
similar to enforcement problems that led Congress to grant exceptions
to the statute in other situations, and (3) identify possible
advantages and disadvantages of an exception to the statute for
offshore examinations.
To do our work, we (1) analyzed IRS data, reports, publications, and
other documentation providing insight into the characteristics,
complexity, and size of the offshore tax evasion problem;[Footnote 1]
(2) compared IRS data on the amount of time required to complete
examinations involving an offshore component[Footnote 2] with those
lacking such a component and the recommended assessments from those
examinations; (3) reviewed selected IRS files to illustrate
examinations of returns involving offshore components; (4) researched
the history of the federal statute of limitations for assessments to
include legislation proposed between 2003 and 2006 that included
references to either offshore tax evasion or the statute of
limitations; (5) interviewed representatives of California's taxing
authority, the California Franchise Tax Board (FTB), and reviewed
documents related to a recent change in California's statute related to
certain abusive tax shelters; (6) interviewed revenue agents and
managers with expertise in offshore cases to develop an understanding
of IRS enforcement activities; and (7) interviewed IRS officials and
others in the tax practitioner and policy communities about their views
on extending the examination period for returns involving offshore
schemes. We assessed the reliability of the IRS data that we used and
found that it was sufficiently reliable for our purposes. The universe
of IRS examinations with an offshore component included individual
taxpayers, smaller and larger corporations, and other taxable entities.
The database of all nonoffshore examinations we used for comparison
similarly included a full range of taxpayers. Details on our
methodology can be found in appendix I. We did our work from June 2005
through February 2007 in accordance with generally accepted government
auditing standards.
Results in Brief:
Identifying possibly noncompliant returns, gathering appropriate
evidence, and completing an examination takes much more time for IRS
for tax returns involving abusive offshore transactions than other
types of returns. Where IRS is able to complete examinations involving
abusive offshore transactions, they generally result in larger
assessments than other types of examinations. IRS officials told us
that because the same 3-year statute of limitations that applies to
nonoffshore examinations applies to offshore examinations, the
additional time needed to complete an offshore examination means that
IRS sometimes has to end offshore examinations before the examination
is complete, and sometimes chooses not to open an examination at all,
despite evidence of likely noncompliance. Although data were not
available to measure the effect of the statute of limitations on
assessments, IRS revenue agents and their managers told us that overall
assessments for offshore examinations are lower than they would be if
IRS had more time to work these examinations.
Some offshore examinations exhibit enforcement problems similar to
those where Congress has granted a change or exception to the statute
in the past. For example, the issues that led to the creation of the
statute exception for certain abusive tax shelters are similar to those
exhibited by offshore examinations. Past statute changes and exceptions
provide precedent for changing the statute for offshore examinations.
Through discussions with IRS officials and others in the tax
practitioner and policy communities, we identified both advantages and
disadvantages of extending the statute of limitations. Among the
advantages were increased flexibility for IRS to direct enforcement
resources to egregious cases of noncompliance and a possible deterrent
effect against future noncompliance. Disadvantages included increased
uncertainty and lack of closure for taxpayers as well as increased
taxpayer perceptions of unfairness unless an extension to the statute
for assessments is matched by an extended refund period. Our commenters
also discussed design options to mitigate some of the disadvantages of
the statute extension, such as making an exception apply to all
taxpayers having offshore accounts/entities, and thereby, mitigating
taxpayer uncertainty and lack of closure. Maintaining symmetry between
the statutes for assessments and refunds was also mentioned as
mitigating taxpayer perceptions of unfairness about extending the
statute for assessments.
In this report, we suggest that Congress make an exception to the 3-
year civil statute assessment period for taxpayers involved in offshore
financial activity. In comments on a draft of this report, IRS
officials commented that a longer statute for offshore examinations
makes sense and should enhance compliance. IRS also provided comments
on several technical issues and legal issues, which we incorporated in
this report where appropriate.
Background:
It is perfectly legal for U.S. taxpayers to hold money offshore. It is
illegal, however, for a taxpayer to not disclose substantial offshore
holdings, to not report income earned in the United States and "hidden"
through offshore arrangements, and to not report income earned offshore
to IRS on the taxpayer's tax return. If U.S. taxpayers own an offshore
business such as a foreign corporation, they are required to disclose
that holding to IRS on their tax return. When applied to abusive
transactions, IRS generally uses the term "offshore" to mean a country
or jurisdiction that offers financial secrecy laws in an effort to
attract investment from outside its borders.[Footnote 3] When referring
to a financial institution, "offshore" refers to a financial
institution that primarily offers its services to persons domiciled
outside the jurisdiction of the country in which the financial
institution is organized.
Abusive offshore schemes are often accomplished through the use of
limited liability corporations (LLC), limited liability partnerships
(LLP), international business corporations (IBC), and trusts, foreign
financial accounts, debit or credit cards, and other similar
instruments. According to IRS, the schemes can be complex, often
involving multiple layers and multiple transactions used to hide the
true nature and ownership of the assets or income that the taxpayer is
attempting to hide from IRS.
IRS has multiple programs and techniques used to select potentially
noncompliant tax returns for examination. One source is a computer
model designed to predict returns that, if audited, would be most
likely to result in additional taxes owed. Other sources that prompt an
examination include referrals from inside or outside IRS, information
from third parties, and indications of fraud or noncompliance from
other audits. Once IRS has identified a return for an examination, the
classification process begins. Classification is the process of
determining whether a return should be selected for examination, what
issues should be examined, and how the examination should be conducted.
IRS guidance on classification states that classification should be
conducted by an experienced examiner.
Examination is the accumulation of evidence for evaluating the accuracy
of the taxpayer's tax return. Examiners gather facts to correctly
determine a taxpayer's tax liability. Evidence can include the
taxpayer's testimony and books and records as well as the examiner's
own observations and documents from third parties. Methods for
accumulation of evidence include analytical tests, documentation,
inquiry, inspection, observation, and testing. IRS procedures call for
examiners to pursue an examination to the point where a reasonable
determination of correct tax liability can be made. In turn, examiners
prepare audit reports, which should contain all information necessary
to ensure a clear understanding of the adjustment, if any, and document
how the tax liability was computed. These reports serve as the basis
for assessment actions. An assessment records the taxpayer's liability
due.[Footnote 4]
IRS examinations are generally of one of three types--correspondence,
office, or field. The simplest examinations usually cover one to two
tax issues handled by a lower-graded examiner through correspondence.
More complex examinations are done by meeting with taxpayers or their
representatives in IRS offices. The most complex examinations are done
through revenue agent field visits to taxpayer locations. Only about 16
percent of all IRS examinations from 2002 through 2005 were conducted
through field examinations, but 98 percent of offshore examinations
were of this type. About three-fourths of nonoffshore examinations are
handled through correspondence.
IRS does not classify every return that is filed, nor does it examine
every case file that is classified, even if IRS determines that
examining the tax return would likely yield an assessment of additional
taxes owed. Figure 1 provides a notional representation of the process
of taking the over 130 million individual income tax returns that were
filed in fiscal year 2004 through the steps that lead to audits of a
much smaller number of those returns.
Figure 1: Notional Representation of IRS Audit Selection Process:
[See PDF for image]
Source: GAO analysis of IRS data.
[End of figure]
In most cases, the law gives IRS 3 years from the date a taxpayer files
a tax return to complete an examination and make an assessment of any
additional tax. For example, if a taxpayer filed a tax return on April
15, 2000, IRS had until April 15, 2003, to finish any examination of
that return and make an assessment of additional taxes owed by the
taxpayer. This statute of limitations for assessments is in effect for
all examinations with exceptions allowing longer periods for certain
taxpayer actions or omissions such as fraud or substantial
understatement of gross income (in excess of 25 percent of the amount
of gross income stated on the return). Taxpayers may also waive the 3-
year assessment limitation through written consent.
Offshore Examinations Take Longer Than Other Examinations, so the 3-
Year Statute Can Lead to Lower Assessments Than Would Otherwise Be
Possible:
In general, it takes longer for IRS to identify and examine tax returns
involving abusive offshore transactions than IRS needs in nonoffshore
cases because of the added complexity of examining offshore
transactions. Where IRS is able to complete examinations involving
abusive offshore transactions, they generally result in larger
assessments than other types of examinations. IRS has policies in place
to avoid violating the statute of limitations, and IRS enforcement
personnel told us that these policies, in conjunction with the longer
time needed to complete offshore examinations, mean some cases are
never opened in the first place while others are not fully worked
because the time allowed under the current statute is running out. As a
result, they said, overall assessments for offshore cases are lower
than they would be if IRS had more time to work these cases.
Offshore Cases Take Longer for IRS to Develop and Examine:
IRS officials told us that cases involving offshore tax evasion present
special, time-consuming challenges that other types of cases do not.
Tax evasion, both domestic and offshore, often involves schemes with
many layers of deception. IRS officials told us that for domestic tax
evasion, revenue agents are able to issue summonses to domestic
financial institutions to uncover the layers of deception the taxpayer
created to hide the source and existence of the funds. In offshore
cases, IRS generally does not have summons power over offshore
financial institutions, and is often unable to determine the owner of
an offshore account or business, or determine the source of the funds.
Even in cases where IRS is able to determine information about offshore
funds, an IRS manager told us that this process of discovery is much
more time consuming than for nonoffshore cases.
Unlike much nonoffshore tax evasion, most possible offshore tax evasion
cases are not discovered through IRS's computerized analysis of tax
returns, but rather through investigations of promoters of offshore
schemes. Officials told us that several divisions of IRS forward leads
on the promoters of offshore schemes they discover to revenue agents,
who develop the cases in order to discover the extent of the promoter's
use of offshore schemes. This process takes far longer than computer
analysis-based methods of identifying potential noncompliance.
After developing information that a promoter of offshore schemes
illegally sold schemes to help taxpayers avoid their tax liability, IRS
can refer that information to the Department of Justice, which can then
file a complaint in the United States District Court requesting the
court to issue an injunction against the promoter. In some cases, the
injunction will compel the promoter to disclose the clients who
purchased the scheme. IRS officials told us that it can take years to
get a client list from a promoter and, even with a client list, there
is still much work that IRS needs to do before the clients of the
offshore schemes can be audited. For example, IRS officials told us
that they may only get limited information about the clients of
offshore promoters, and often that information is limited to a name and
perhaps the city and state where the client lives, so considerable time
may be spent finding the individuals listed by the promoter.
Time spent developing information on a return before putting it into
the queue for examination shortens the time available to close the
examination before the 3-year civil statute of limitations expires.
Table 1 compares the median number of days spent in development for
offshore and nonoffshore examinations from 2002 to 2005.[Footnote 5] As
shown in the table, the median offshore case took 184 more calendar
days than the median nonoffshore case to move from filing to
examination. Comparing just field examinations, which constituted over
98 percent of offshore examinations in fiscal years 2002 through 2005,
the difference in median development time was 96 days. Some
examinations lead to additional examinations of the same taxpayer's
returns, such as when a revenue agent identifies noncompliance on one
return and then reviews prior year returns looking for the same
problem, or when a taxpayer files a new return while an examination is
underway. To avoid overstating development time, this comparison
includes only the number of days between the start of the examination
and the filing date of the last return filed before the examination
began.[Footnote 6]
Table 1: Median Development Days by Examination Type, Fiscal Years 2002-
2005:
Examination type: Offshore;
Median days in development, all examinations: 504;
Median days in development, field examinations only: 504.
Examination type: Nonoffshore;
Median days in development, all examinations: 320;
Median days in development, field examinations only: 408.
Source: GAO analysis of IRS data.
Note: Medians in this table are not based on analysis of all
examinations. Our calculations included only one examination where a
single taxpayer is the subject of two or more related examinations.
[End of table]
Once offshore cases are developed and moved into examination, the
examinations take longer than nonoffshore cases. Considering all types
of examinations together, the median offshore examination took 90 more
days than the median nonoffshore examination. Considering field
examinations alone, the median offshore field examination was 70 days
longer than the median nonoffshore field examination, as shown in table
2. IRS officials told us that this is due to examination complexity and
the difficulty of identifying and obtaining information from foreign
sources.
Table 2: Median Examination Days by Examination Type, Fiscal Years 2002-
2005:
Examination type: Offshore;
Total number of examinations: 6,720;
Median number of days, all examinations: 275;
Number of field examinations only: 6,597;
Median number of days, field examinations: 279.
Examination type: Nonoffshore;
Total number of examinations: 4,134,870;
Median number of days, all examinations: 185;
Number of field examinations only: 653,239;
Median number of days, field examinations: 209.
Source: GAO analysis of IRS data.
[End of table]
The total time that elapses between a return being filed and IRS's
closing of the examination of that return is referred to as total cycle
time and provides another type of comparison between offshore and
nonoffshore cases. As shown in table 3, the median offshore examination
took almost 500 more calendar days overall to close than the median
nonoffshore examination, a 126 percent difference. The median offshore
case took 82 percent of the statute time versus 36 percent for
nonoffshore cases. Considering just field examinations, the median
cycle times for offshore and nonoffshore examinations were closer in
length, but the median offshore examination was still 194 days longer,
a difference of 28 percent.
Table 3: Median Total Cycle Time by Case Type, Fiscal Years 2002-2005:
Case type: Offshore;
All examinations: Median cycle time, in days: 896;
All examinations: Percentage of statute time used by IRS to close case:
82;
Field examinations only: Median cycle time, in days: 896;
Field examinations only: Percentage of statute time used by IRS to
close case: 82.
Case type: Nonoffshore;
All examinations: Median cycle time, in days: 397;
All examinations: Percentage of statute time used by IRS to close case:
36;
Field examinations only: Median cycle time, in days: 702;
Field examinations only: Percentage of statute time used by IRS to
close case: 64.
Source: GAO analysis of IRS data.
Note: The median day figures in tables 1 and 2 are drawn from different
populations, so they do not add up to the median day figures in table
3.
[End of table]
Completed Offshore Examinations Yield Larger Recommended Assessments
Than Other Examinations:
About half of all offshore examinations resulted in a recommended
assessment of additional taxes due compared to approximately 70 percent
of nonoffshore examinations. While less frequent, assessments from all
types of offshore examinations--correspondence, office and field--had a
median that was nearly 3 times larger than from nonoffshore
examinations. Considering just field examinations, recommended
assessments from offshore examinations also had a median that was much
larger than nonoffshore examinations, though by a smaller margin, as
shown in table 4.
Table 4: Median Assessments by Examination Type, Fiscal Years 2002-
2005:
Examination type: Offshore;
All examinations: Number of examinations resulting in an assessment:
3,247;
All examinations: Median assessment, in dollars: 7,933;
Field examinations only: Number of examinations resulting in an
assessment: 3,166;
Field examinations only: Median assessment, in dollars: 7,848.
Examination type: Nonoffshore;
All examinations: Number of examinations resulting in an assessment:
2,899,957;
All examinations: Median assessment, in dollars: 2,877;
Field examinations only: Number of examinations resulting in an
assessment: 359,272;
Field examinations only: Median assessment, in dollars: 4,529.
Source: GAO analysis of IRS data.
[End of table]
While yielding larger assessments, the greater amount of time spent on
offshore examinations means that their yield per hour of direct
examination time is lower.[Footnote 7] Considering all types of
examinations together, including both those that resulted in an
assessment and those that did not, offshore examinations yielded less
per hour of direct examination time than nonoffshore examinations
because the number of hours spent on those examinations is nearly 4
times longer, on average. From 2002 to 2005, IRS examiners spent an
average of 46 hours on all types of offshore examinations, compared to
an average of only 12 hours for all types of nonoffshore examinations.
Considering only field examinations, average hours per examination were
47 for offshore examinations versus 62 for nonoffshore examinations,
and the difference in dollars per hour of direct examination time is
greater.[Footnote 8]
Table 5: Assessment Dollars per Examination Hour by Examination Type,
Fiscal Years 2002-2005:
Offshore;
Total dollars per hour of examiner time, all examinations: 1,084;
Total dollars per hour of examiner time, field examinations only:
1,073.
Nonoffshore;
Total dollars per hour of examiner time, all examinations: 2,156;
Total dollars per hour of examiner time, field examinations only:
2,824.
Source: GAO analysis of IRS data.
Note: Unlike table 4, table 5 considers all examinations, including
those that did not result in an assessment.
[End of table]
To Prevent Violating the Statute of Limitations, IRS Does Not Pursue
Some Likely Offshore Tax Evasion:
IRS has strict policies to prevent examinations from going past the
statute of limitations because if an assessment is not made within 3
years, the statute of limitations bars IRS from making any assessment
at all. Such instances mean the loss of revenue to IRS and inefficient
use of IRS examination resources. IRS policies specify that statute
expiration dates for all tax returns be properly determined, that all
records be annotated with these dates, and that the cases be closely
monitored to prevent accidentally running out of time. Revenue agents
and managers told us that IRS strongly emphasizes the importance of
keeping track of these dates and avoiding allowing an examination to go
past the statute date.
While the 3-year statute of limitations applies in most cases, some
exceptions exist under current law. For example, an assessment may be
made after the 3-year point if the tax return is false or fraudulent or
if there is a sufficiently large omission of gross income. Taxpayers
may also agree to waive their statute rights.
In the rare cases where IRS personnel allow an examination to go past
the statute without meeting one of the current exceptions to the
statute (a "barred statute"), the responsible agent and his or her
manager must prepare a Barred Statute Report and face possible
disciplinary action because of the examination time spent with no
possibility of making an assessment. IRS data for fiscal years 2005 and
2006 showed 39 barred statutes associated with examinations where a
manager made an initial determination to recommend a disciplinary
action. As shown in table 6, most of these barred statutes ultimately
resulted in some type of disciplinary action.
Table 6: Disposition of Cases When a Disciplinary Action Stemming from
a Barred Statute Was Initially Recommended, Fiscal Years 2005-2006:
Disciplinary action: No action, withdrawn, closed;
2005: 3;
2006: 1;
Total: 4.
Disciplinary action: Counseling, admonishment, reprimand;
2005: 20;
2006: 11;
Total: 31.
Disciplinary action: Suspension, removal, resignation;
2005: 3;
2006: 1;
Total: 4.
Disciplinary action: Total;
2005: 26;
2006: 13;
Total: 39.
Source: GAO analysis of IRS data.
Note: These disciplinary actions include all types of examination
cases, both offshore and nonoffshore.
[End of table]
IRS has created guidance for continuing offshore examinations past the
3-year point. This guidance permits agents to request permission to
carry on the examination past the 3-year point based on their judgment
that, given additional time, they will be able to ultimately prove that
the examination meets one of the following three conditions:[Footnote
9]
1. The return is false or fraudulent. IRS defines false or fraudulent
as the preparation and filing of false income tax returns by claiming
inflated personal or business expenses, false deductions, unallowable
credits, or excessive exemptions.
2. There is a sufficiently large omission of gross income (in excess of
25 percent of the amount of gross income stated on the return) under
IRC 6501(e), in which case the tax may be assessed at any time within 6
years after the return is filed.
3. The taxpayer failed to notify the Secretary of the Treasury of
certain foreign transfers under IRC 6501(c)(8), in which case the
statute of limitations is 3 years from the date IRS receives the
required information.[Footnote 10]
A conclusion to continue an examination beyond the statute must be
approved in writing by IRS managers, based on the revenue agent's
documentation of the rationale and calculations to support this
conclusion. In addition, IRS must have made a timely and proper request
to the taxpayer to obtain a consent agreement to extend the statute.
The taxpayer's refusal to extend the statute or lack of response must
be documented. If this guidance is followed, no disciplinary action
will be taken against the IRS managers and agents if the examination
ultimately does not prove to meet one of the three conditions for
making an assessment after 3 years.
The IRS guidance allowing some examinations to go past the normal
statute period based on the revenue agent's judgment that an assessment
will be possible after the 3-year point recognizes the limited time
available to agents to finalize case-specific facts when the 3-year
statute is about to expire. The IRS guidance also notes that the Credit
Card Summons project examinations are generally likely to involve
unreported income or fraud as well as failure to file information
returns reporting foreign transfers. The guidance also states that
other offshore examinations share many of the same challenges as Credit
Card Summons project examinations including complex examinations and
securing documents located outside the United States.[Footnote 11]
IRS managers told us that this procedure for continuing examinations
beyond the statute is cumbersome, time-consuming, and some agents are
reluctant to use the procedure because of concerns about barred
statutes. Revenue agents told us that this reluctance stems from the
culture of IRS examiners where agents are instructed from the time they
are hired to never let an examination go past the statute of
limitations for any reason. Despite subsequent assurances from IRS
guidance, however, revenue agents told us that ingrained reluctance to
letting the statute of limitations pass is still paramount.
All of the examinations allowed to extend past the statute date under
this guidance represent a gamble on the part of IRS that the
examination will ultimately meet one of the exceptions to the statute
and an assessment will be allowed under the law. IRS records show that
1,942 offshore examinations were taken past the 3-year statute period
from fiscal years 2002 through 2005. IRS ultimately made assessments on
63 percent of these examinations and these assessments were
significantly higher than assessments from all other types of
examinations, with a median assessment of about $17,500 versus about
$5,800 from offshore examinations that were closed within the 3-year
statute of limitations and $2,900 from all nonoffshore examinations
closed within 3 years.[Footnote 12] IRS databases do not allow
systematic analysis of the approximately 700 examinations that did not
result in an assessment, so we do not know if these were accurate
returns or if the discovered tax evasion just did not rise to the level
of fraud or substantial understatement of income.
For those examinations that closed with an assessment, longer
examinations did not change the median assessment amount significantly
for nonoffshore examinations. On the other hand, offshore examinations
produced much larger median assessments than both shorter offshore
examinations and all nonoffshore examinations when the examinations
themselves took 3 years or more, as shown in figure 2. A similar
relationship is found for field examinations alone, as shown in figure
3.
Figure 2: Median Assessment Amount by Number of Examination Days, All
Examinations Closed with an Assessment, Fiscal Years 2002-2005:
[See PDF for image]
Source: GAO analysis of IRS data.
[End of figure]
Figure 3: Median Assessment Amount by Number of Examination Days, Field
Examinations Closed with an Assessment, Fiscal Years 2002-2005:
[See PDF for image]
Source: GAO analysis of IRS data.
[End of figure]
Similarly, our analysis of assessment dollars generated per hour of
examination time (including examinations both with and without
assessments) showed that the yield increased markedly for offshore
examinations that take more than 3 years. While average assessment
dollars per hour of direct offshore examination time are about half of
the average for nonoffshore examinations, the reverse is the case for
examinations that go over three years--$6,458 per hour for offshore
examinations compared to $3,432 per hour for nonoffshore examinations.
The comparison is nearly the same for field examinations alone--$6,465
per hour for offshore field examinations and $3,454 per hour for
nonoffshore field examinations.
Revenue agents and managers told us that some developed case files are
not opened for examination because insufficient time remains under the
statute to make the examination worthwhile. They said that managers and
agents have leeway in deciding which examinations to work because there
are usually more developed case files waiting for agents than there are
agents to work them. IRS wants agents to work examinations with a good
likelihood of leading to meaningful assessments; managers told us they
look for examinations that have both apparent noncompliance and
sufficient time remaining within the statute to fully develop the
apparent issues. Revenue agents and IRS managers told us that, in order
to avoid violating the statute, they will often choose case files to
examine with more time remaining under the 3-year statute of
limitations over case files with less time remaining but with more
likely or more substantial possible assessments. As a result, they
explained that not all case files in the unassigned inventory of case
files developed for examination are selected for examination and many
case files are "surveyed," or closed without examination.[Footnote 13]
Two IRS policies could contribute to closing a developed offshore case
without an examination. One of these policies requires sorting the
unassigned inventory to identify the areas most in need of examination.
This policy includes statute year and statute date among the attributes
used in sorting unassigned inventory. A second policy requires that an
examiner not begin an examination or requisition any return for audit
without management approval if fewer than 12 months remain on the
statutory period for assessment. As described earlier, offshore
examinations typically require more time to develop than nonoffshore
examinations, and as a result, offshore examinations in the queue for
examination would typically be nearer the end of the assessment period
than nonoffshore examinations. IRS managers explained that this
attribute of offshore examinations can lead to leaving offshore cases
in the queue until the statute period ends and then closing the case
without an examination.
Agents and managers also said that they often choose to end an ongoing
examination nearing the end of the 3-year assessment period without
making a complete assessment rather than risk taking the examination
past the statute period, losing revenue, and facing disciplinary
action. IRS agents and managers told us that they face difficult
choices as an examination nears the end of the 3-year assessment period
and the examination is incomplete. On the one hand, the examination can
be discontinued. This choice is the safest for individual IRS agents
and managers because it avoids the possibility of a Barred Statute
Report and disciplinary actions. However, this choice also results in
an assessment that does not accurately reflect the extent of a
taxpayer's compliance or noncompliance with tax laws because the
examination is incomplete. Continuing the examination can result in an
accurate assessment, but only if the examination demonstrates one or
more of the exceptions to the statute described earlier. If the
examination does not ultimately demonstrate fraud or another basis for
an exception, IRS managers and agents wasted IRS resources because they
are barred from making an assessment. Revenue agents told us that they
believed that in some cases there is "money being left on the table" in
the form of unexamined issues that could have led to assessments if
there had been sufficient time to examine them.
Even where there is sufficient time to work an examination, only a few
years where a taxpayer was using a particular scheme may be open to
examination and the early years of a scheme may be past their statute
date before the examination even begins. For example, if IRS is
examining a taxpayer's 2005 tax return and discovers a significant
understatement in the income that the taxpayer reported, the agent can
examine some of the taxpayer's previous returns, but unless the revenue
agent and manager suspect fraud, in which case there is not a statute
of limitations, IRS must abide by the 3-year statute of limitations on
assessments and not examine some prior years that taxpayers held money
offshore illegally. A senior IRS official told us that this is a
particularly significant problem because it is often in the first years
of an offshore scheme where the taxpayer moves the most money offshore
and the most egregious tax evasion takes place, so IRS is missing out
on significant assessments by not being able to look back at previous
tax returns.
IRS revenue agents are not able to accurately estimate likely possible
assessments for case files or tax years that are unexamined. Similarly,
in cases where an examination is started and subsequently closed
without some issues being examined due to the statute of limitations,
it is not possible to estimate the likely assessment from unexamined
issues.
As mentioned earlier, however, we found that 1,942 offshore
examinations were allowed, either by IRS decision or by a voluntary
statute extension signed by the taxpayer under examination, to exceed
the 3-year statute of limitations. Of those, more than 700 were closed
without an additional tax assessment. IRS officials told us that many
of the offshore examinations that go past the 3-year statute of
limitations are very difficult to work due to complex financial
arrangements and that even with significantly more time, some
particularly complex and well-hidden offshore schemes would remain very
difficult to uncover. IRS data did not show the reasons that the 700
offshore examinations that went past the 3-year statute of limitations
were closed without an assessment.
Some Offshore Examinations Present Enforcement Problems Similar to
Those Where Congress Granted Changes to the Statute:
Some offshore examinations exhibit compliance problems similar to those
where Congress granted a change or exception to the statute in the
past. Offshore examinations take longer than nonoffshore examinations
for IRS to develop and examine for reasons such as technical complexity
and the difficulty of obtaining information from foreign sources, and
as a result, IRS may not complete assessments of all taxes owed. These
problems are similar to problems giving rise to other changes and
exceptions to the statute at both the federal and state levels over the
years. These changes and exceptions provide precedent for changing the
statute for offshore examinations.
Offshore Enforcement Problems Are Similar to Those Justifying Past
Changes to the Statute:
Offshore examinations present IRS with various enforcement problems. As
discussed above, offshore examinations take longer to develop and
examine. IRS officials told us that this is due to the examinations'
complexity and difficulty in identifying and obtaining information from
foreign sources. Agents and managers also said that they often choose
to end an ongoing examination nearing the end of the 3-year assessment
period without making a complete assessment rather than risk taking the
examination past the statute period, losing revenue, and facing
disciplinary actions. Further, agents and managers explained that some
taxpayers or their representatives employ dilatory, uncooperative
tactics when dealing with IRS. In addition, we previously
testified[Footnote 14] that the use of offshore schemes can also pose a
threat to the integrity and fairness of our tax system by adversely
affecting voluntary compliance if honest taxpayers believe that
significant numbers of individuals are not paying their fair share of
the tax burden.
We reviewed 12 IRS offshore case files and found examples of (1)
technical complexity, (2) difficulty in identifying and obtaining
information from foreign sources, and (3) taxpayers or their
representatives employing dilatory, uncooperative tactics when dealing
with IRS. We also found a wide variety of offshore examinations, from
very simple examinations to much more complex examinations that had
been under examination for years. In order to obtain illustrative
examples of offshore examinations, we reviewed examinations that took a
shorter than average number of days to complete, about an average
number of days, and a longer than average number of days. We reviewed
case files in two locations and our reviews included both completed
examinations and examinations still in progress. These examinations
included some that had no changes to the taxpayer. The two examinations
described below include one that took a relatively low number of days
and one that took a longer than average number of days.
In the first examination, the taxpayer was identified as holding an
offshore credit card in a country considered to be a tax haven. The
taxpayer maintained that he did not have an offshore credit card. IRS
used a summons to obtain records of a domestic rental car transaction
that would identify the holder of the offshore credit card. While the
name shown on the rental car records was similar to the taxpayer's
name, it was not the taxpayer's name. After reviewing the rental car
records, the revenue agent concluded that the taxpayer was not the
holder of the offshore credit card. The examination had no other issues
and resulted in no change in the amount of tax owed by the taxpayer. In
conducting this examination, the revenue agent:
* sent 4 pieces of correspondence to the taxpayer,
* conducted 1 interview with taxpayer,
* notified the taxpayer of third-party contact, and:
* used 1 summons to obtain domestic rental car records; the summons was
returned 33 days after it was issued.
In the second examination, the taxpayer had a number of businesses in
the United States and in other countries, including at least one
business in a tax haven country. It appeared that some of the
taxpayer's businesses paid consulting fees to other businesses the
taxpayer owned, and consulting fees were paid into an offshore account
in a tax haven country through which the taxpayer received funds via a
credit card.
IRS found it difficult to determine how much money was in the
taxpayer's offshore tax haven business and how the money got there. The
money in that business, IRS told us, is the lynchpin of the entire
examination, which was still underway at the time of our review. During
the 4 years that the examination had been underway, IRS opened
examinations on the taxpayer's spouse and on other businesses in other
tax years. IRS has not been able to find where some of the money is
going, although officials are confident that more is being hidden as
the taxpayer had other businesses that made payments to the business in
the offshore tax haven country. Over the 4 years of this examination,
there have been at least:
* 5 powers of attorney,
* 20 summonses,
* 39 contacts with the taxpayer's power of attorney,
* 23 document requests,
* 5 missed appointments by taxpayer or taxpayer's representative,
* 1 statute extension,
* 2 interview requests denied,
* 5 meetings with taxpayer's representative,
* 4 postponed appointments,
* 4 third-party contacts, and:
* 2 occasions on which the taxpayer refused to supply information.
The scheme began, as far as IRS can tell, in the late-1990s, but
examinations of some early years of the taxpayer's scheme were
statutorily barred. This means that, when the examination eventually
closes, IRS will not be able to assess any additional taxes on at least
some tax years that IRS agents found the taxpayer was holding money
offshore unless they determine that fraud was committed.
Enforcement problems exhibited in the 12 cases we reviewed are similar
to enforcement problems justifying changes and exceptions to the
statute at both the federal and state levels over the years. For
example, the statute was recently changed at both the federal and state
levels to address specific compliance problems, such as dilatory
tactics on the part of taxpayers and the use of technically complex
transactions. The following details on legislative actions illustrate
instances where changes and exceptions to the statute were granted at
both the federal and state levels because of enforcement problems
similar to those exhibited by offshore examinations such as (1) time
constraints on IRS; (2) taxpayers delaying examinations through
dilatory, uncooperative tactics on the part of taxpayers; and (3)
failure of taxpayers to provide required information.
Historical Changes and Exceptions:
The Revenue Act of 1934[Footnote 15] provided the current 3-year
statute. In making the change in 1934 from 2 to 3 years, the Senate
Report noted that experience showed that the 2-year period was "too
short in a substantial number of large cases, resulting oftentimes in
hastily prepared determinations, with the result that additional
burdens are thrown upon taxpayers in contesting ill-advised
assessments. In other cases, revenue is lost by reason of the fact that
sufficient time is not allowed for disclosure of all the facts."
As discussed above, Congress has also provided exceptions to this 3-
year assessment period. For example, the exception for filing a false
or fraudulent return dates back to the Revenue Act of 1916.[Footnote
16] Where this exception applies, the assessment can be made at any
time. Similarly, the exception for significant omissions of gross
income dates back to the Revenue Act of 1934. Where this exception
applies, the tax may be assessed at any time within 6 years after the
return is filed. According to the legislative history for the 1934 Act,
this provision was added to enlarge the scope of the existing exception
allowed for false or fraudulent returns while limiting the exception
where a taxpayer may have made an honest mistake and it would be unfair
to keep the statute open indefinitely. The exception to the statute of
limitations for failure to report certain foreign transactions dates
back to the Taxpayer Relief Act of 1997.[Footnote 17] This exception
was included and grouped along with certain other changes designed to
simplify formation and operation of international joint ventures.
Recent Federal Exception to the Statute:
More recently, Congress changed the statute to provide IRS with
additional time to make assessments in the case of unreported listed
transactions.[Footnote 18] With the American Jobs Creation Act of
2004,[Footnote 19] Congress extended the statute for unreported listed
transactions for 1 year after the earlier of (1) the date the
information required to be reported is provided or (2) a material
advisor meets the requirements for providing a list of investors in the
listed transaction.
Listed transactions are complex transactions that manipulate parts of
the tax code or regulations and are typically buried among "legitimate"
transactions reported on tax returns. Because the transactions are
often composed of many pieces located in several parts of a complex tax
return, they are essentially hidden from plain sight, which contributes
to the difficulty of determining the scope of the abusive shelter
problem. Often lacking economic substance or a business purpose other
than generating tax benefits, abusive shelters are promoted by some tax
professionals, often in confidence, for significant fees, sometimes
with the participation of tax-indifferent parties, such as foreign or
tax-exempt entities. They may involve unnecessary steps and flow-
through entities, such as partnerships, which make detection of these
transactions more difficult. The transactions are marketed to wealthy
individuals, large corporations, and small business taxpayers. Section
6111 of the Internal Revenue Code requires the promoter or other tax
shelter organizer to report such transactions with IRS. Further,
Department of the Treasury regulations[Footnote 20] require promoters
to maintain lists of investors who have entered into the transactions
and investors to disclose the transactions into which they have
entered.
In a March 2006 report, for example, the Treasury Inspector General for
Tax Administration (TIGTA) described a type of listed transaction
called Son of Boss (Bond and Option Sales Strategies).[Footnote 21]
According to TIGTA, this transaction used flow-through entities, such
as partnerships, and various financial products to add steps and
complexity to transactions that had little or no relationship to the
investor's business or the asset sale creating the sheltered gain.
TIGTA further explained that the losses generated from the transactions
were often reported among "legitimate" items in several parts of the
tax return. TIGTA concluded that taken together, these characteristics,
especially the use of flow-through entities, made it very difficult for
IRS to detect the Son of Boss abusive tax shelter through its
traditional process of screening returns individually for questionable
items. TIGTA noted that examinations of abusive tax shelters can take
significant amounts of time even for the most experienced examiners
because such shelters often involve complex, technical transactions
that take on different variations and require examining multiple flow-
through entities to make a proper tax determination.
At the time of our review, IRS representatives stated that sufficient
time had not elapsed to determine to what extent, if any, the 1-year
extension for unreported listed transactions improved examination
effectiveness. An IRS analyst explained, however, that the 1-year
extension resulted in increased disclosures of previously undisclosed
listed transactions. This analyst stated that 35 taxpayers made 74
separate disclosures about previously unreported listed transactions
and that 8 of these 74 disclosures were duplicates.
California Statute Change:
At the state level, California recently extended its statute from 4 to
8 years for taxpayers that invest in an abusive tax shelter (ATS)
transaction. Such transactions include IRS listed transactions and
other schemes of particular importance to California. According to the
California Legislative Analyst's Office (LAO), the key feature of these
transactions is that they have no true economic purpose but exist
solely for reasons of tax avoidance. Among their characteristics is the
use of (1) pass-through entities such as partnerships, (2) third party
facilitators, and (3) offshore accounts or facilitators. The LAO
further explained that ATS transactions can be quite difficult to
identify and often even harder to understand, even for trained tax
auditors.
As with IRS, California experienced increased disclosure as a result of
extending its assessment period from 4 to 8 years for taxpayers
involved in ATS transactions. A California FTB manager stated that the
newly enacted 8-year statute had not been applied because most tax
shelter examinations are closed within the normal 4-year period or by
requesting voluntary waivers. It should be noted that California's
assessment period is 1 year longer than the federal 3-year assessment
period. The FTB manager also cited two sources of examinations in which
the normal 4-year statute had expired but taxpayers were willing to
work to resolve their tax shelter issues. These sources were the Self
Compliance Letters[Footnote 22] and the California Tax Shelter
Resolution Initiative.[Footnote 23] The California FTB used a self
compliance letter to solicit amended returns from taxpayers for at
least 1 year in which the 4-year statute had expired. This letter cited
the 8-year statute. At the time of our review, 13 taxpayers filed
amended returns, which reported tax and interest of about $2.3 million.
Additional penalties may apply to these 13 taxpayers. Another 48
taxpayers agreed to file amended returns with estimated taxes and
penalties of about $7 million. Under the California Resolution
Initiative, the FTB was accepting applications and drafting closing
agreements with another 181 taxpayers who had at least 1 tax year for
which the 4-year statute had either expired or was about to expire.
Legislative Reports Discuss Reasons for Change:
The justification for extending the statute for unreported listed
transactions at the federal level and for ATS transactions in
California generally involved qualitative factors. A House of
Representatives Report[Footnote 24] accompanying the American Jobs
Creation Act of 2004 states that "some taxpayers and their advisors
have been employing dilatory tactics and failing to cooperate with IRS
in an attempt to avoid liability because of the expiration of the
statute of limitations. The Committee accordingly believes that it is
appropriate to extend the statute of limitations for unreported listed
transactions."
While not enacted, Senate bill 476 (CARE Act of 2003) included a
provision similar to the provision of the American Jobs Creation Act of
2004 that extended the statute for unreported listed transactions. A
Senate Report[Footnote 25] accompanying Senate bill 476 states that
"—extending the statute of limitations if a taxpayer required to
disclose a listed transaction fails to do so will afford IRS additional
time to discover the transaction if the taxpayer does not disclose it."
Similarly, the California LAO stated that the time extension for ATS
transactions will allow the FTB to "more fully develop cases that
represent ATS activity and result in a greater sustainment rate at the
appeal level."
In addition to affording more time for IRS to discover undisclosed
transactions, the Senate report accompanying Senate bill 476 also
stated that "extending the statute of limitations if a taxpayer
required to disclose a listed transaction fails to do so will encourage
taxpayers to provide the required disclosure—." In analyzing the
legislation that extended the California assessment period from 4 to 8
years, the California FTB noted that "some taxpayers will continue to
engage in tax avoidance transactions until the risks and costs of
engaging in the transactions are significantly increased."
More generally, tax evasion by some taxpayers can affect the
perceptions of other compliant taxpayers about the fairness and equity
of our tax system. In its report accompanying Senate bill 476, the
Senate Committee on Finance stated that the committee "is aware that
individuals and corporations are increasingly using sophisticated
transactions to avoid or evade Federal income tax. Such a phenomenon
could pose a serious threat to the efficacy of the tax system because
of both the potential loss of revenue and the potential threat to the
integrity of the self-assessment system." Similarly, the California LAO
concluded that tax avoidance "by some taxpayers shifts the relative tax
burden towards taxpayers already in compliance. This principle of
fairness has ramifications for the tax system itself. A perception that
the tax system is not equitable could result in noncompliance and tax
avoidance by an increasing proportion of taxpayers."
Precedent Exists for Changing the Statute for Offshore Examinations:
The Supreme Court found that statutes of limitations find their
justification in necessity and convenience. According to a Supreme
Court opinion, statutes of limitations are practical and pragmatic
devices to spare the court from litigation of stale claims, and the
citizen from being put to his defense after memories have faded,
witnesses have died or disappeared, and evidence has been
lost.[Footnote 26] The opinion goes on to say that statutes of
limitations are by definition arbitrary. Historically, the assessment
statute of limitations has varied in length. For example, the Revenue
Act of 1919[Footnote 27] set the statute of limitations for tax
assessments at 5 years. The statute was changed to 2 years in
1932.[Footnote 28] The current 3-year statute stems from the Revenue
Act of 1934.[Footnote 29] As described above, Congress granted changes
and exceptions to the statute over the years to address various types
of enforcement problems. Given the similarities between the enforcement
problems exhibited by offshore examinations and the enforcement
problems giving rise to past changes and exceptions to the statute,
precedent exists for changing the statute for offshore examinations.
Changing the Statute Would Necessitate Weighing Advantages and
Disadvantages:
Changing the statute for offshore examinations would necessitate
weighing advantages and disadvantages. If Congress wishes to change the
statute for examinations where offshore compliance is the major issue,
certain design options, such as limiting any examination and possible
assessment to those issues attributable to offshore transactions or
only suspending the statute while IRS is waiting for taxpayer responses
to IRS data requests, might mitigate some of the disadvantages of the
statute extension.
Advantages and Disadvantages of Changing the Statute:
Changing the statute for examinations in which offshore transactions
are a major enforcement problem will require weighing both advantages
and disadvantages. In addition to advantages, such as fairness or
deterrence, mentioned earlier as justification for extending the
statute for unreported listed transactions and ATS transactions,
interested parties from various organizations that represent taxpayers
or work with tax issues mentioned other advantages and disadvantages
for an exception to the statute for offshore examinations. For example,
they mentioned the ability of IRS to look back at several tax years
once an offshore scheme is identified as an advantage of such an
exception. On the other hand, they mentioned that such an exception
would further complicate the tax code by adding another provision that
would most likely include complicated criteria addressing offshore
transactions. Table 7 summarizes their views on such an exception in
general.
Table 7: Views of Interested Parties in General on Changing the Statute
for Offshore Examinations:
Advantages:
* Increases perceptions of fairness;
* Enhances deterrent effect;
* Allows IRS to look back at several tax years once a scheme is
identified;
Disadvantages:
* Complicates tax laws by adding complex criteria;
* Creates another precedent for future exceptions;
* Increases uncertainty and lack of closure;
* Increases recordkeeping costs;
* Increases difficulty of marshalling a defense as memories fade and
records disappear;
* Duplicates tools already available to IRS (e.g., fraud, consent
agreements, etc.);
* Increases IRS focus on old returns, which may not be a good use of
IRS resources;
* Increases perceptions of unfairness unless matched by an extended
refund period.
Source: GAO analysis of comments by interested parties from various
organizations that represent taxpayers or that work with tax issues.
These organizations included the American Association of Attorney--
Certified Public Accountants, American Bar Association, American
Institute of Certified Public Accountants, National Association of
Enrolled Agents, National Association of Tax Professionals, National
Society of Accountants, National Society of Tax Professionals, and the
Department of the Treasury (IRS Small Business/Self Employed division,
Taxpayer Advocate Service, IRS Office of Chief Counsel, and Department
of the Treasury Office of Tax Policy).
[End of table]
In commenting on an exception to the statute for offshore examinations,
these interested parties also pointed out advantages and disadvantages
for various design options that could be used to implement such an
exception. These options relate to (1) the scope of an exception and
(2) the way in which IRS is afforded additional time to address the
enforcement problems presented by offshore examinations. Scope refers
to (1) which taxpayers will be subject to the exception and (2) the
extent to which the exception allows IRS to examine a tax return. The
way in which IRS is afforded additional time refers to (1) an extension
to the statute, such as for an additional 3 years from the filing date
of a tax return or (2) a suspension of the statute pending resolution
of a compliance problem, such as slow taxpayer response to IRS records
requests. A suspension is triggered by a specified event or action.
Table 8 presents the views of these interested parties on the
advantages and disadvantages of these design options.
Table 8: Views of Interested Parties on Design Options for Changing the
Statute for Offshore Examinations:
Design option: Exception applies to all taxpayers having offshore
accounts/entities;
Advantages:
* Increases simplicity when compared to a case-by-case approach;
* Increases certainty when compared to a case- by-case approach;
Disadvantages:
* Includes taxpayers having legitimate reasons for offshore
accounts/entities;
* Requires clear criteria defining factors such as offshore account and
offshore entity.
Design option: Exception applies on a case-by-case basis;
Advantages:
* Exempts taxpayers having legitimate reasons for offshore accounts/
entities;
Disadvantages:
* Requires clear criteria defining applicability;
* Requires safeguards to prevent unwarranted application;
* Uncertainty for taxpayers as to whether they are covered.
Design option: Exception applies to entire tax return;
Advantages:
* Maximizes potential for assessment;
Disadvantages:
* Expands examination beyond offshore issues;
* Creates perceptions of unfairness.
Design option: Exception applies to offshore issues only;
Advantages:
* Limits examination to offshore issues;
Disadvantages:
* Requires safeguards to prevent scope expansion to nonoffshore issues.
Design option: Exception in the form of a statute extension;
Advantages:
* Increases time to identify participants;
* Increases time to develop examination;
* Increases time for examination;
Disadvantages:
* May ineffectively identify offshore scheme participants;
* Fails to guarantee information needed for assessment will be provided
within the extended time.
Design option: Exception in the form of a statute suspension;
Advantages:
* Focuses on a specific problem;
* Increases time to address a specific problem;
Disadvantages:
* Requires clear criteria for triggering event;
* Requires triggering event to occur before additional time allowed.
Source: GAO analysis of comments by interested parties from various
organizations that represent taxpayers or that work with tax issues.
These organizations included the American Association of Attorney--
Certified Public Accountants, American Bar Association, American
Institute of Certified Public Accountants, National Association of
Enrolled Agents, National Association of Tax Professionals, National
Society of Accountants, National Society of Tax Professionals, and the
Department of the Treasury (IRS Small Business/Self Employed division,
Taxpayer Advocate Service, IRS Office of Chief Counsel, and Department
of the Treasury Office of Tax Policy).
[End of table]
If Congress wishes to change the statute for examinations where
offshore compliance is a compliance problem, several of the design
options mentioned by interested parties might mitigate some of the
disadvantages of a statute exception for such examinations. To help
clarify their suggestions, we also developed some hypothetical examples
to illustrate their points. Specific suggestions that we heard included
the following:
* Making an exception apply to all taxpayers having offshore accounts/
entities may mitigate concerns about taxpayer uncertainty and lack of
closure.
* Limiting any examination and possible assessment only to those issues
attributable to offshore transactions might mitigate concerns about
unfairly exposing taxpayers to open-ended IRS examinations or "fishing
expeditions" that could result in assessments for issues unrelated to
offshore transactions. For example, an examination triggered by a
taxpayer possessing an offshore credit card could enable the IRS to
examine depreciation expense for the plant and equipment used in the
taxpayer's domestic business, which the taxpayer might perceive as
unfair.
* Suspending the statute until a specific issue is resolved, such as
taxpayers not responding promptly to IRS requests for records, might
mitigate concerns about an across-the-board extension of the 3-year
assessment period.
* Specifying a length of time for an initial extension, such as 1 year,
and requiring a court or review board's approval for any subsequent
extensions might also mitigate taxpayer concerns about potential IRS
abuse of an exception to the statute for offshore examinations. This
option might allay concerns about unwarranted application by IRS of a
case-by-case exception to the statute.
* Establishing a materiality test might mitigate concerns that IRS
would focus on taxpayers having insignificant issues. This test could
be, for example, (1) any amount greater than a percentage of a specific
amount shown on a tax return such as 20 percent of total assets for
taxpayers operating a business or (2) any amount greater than an
absolute dollar amount such as any amount greater than $10,000. This
option might allay concerns about including all taxpayers, particularly
those having legitimate offshore transactions that are not substantial
in value.
* Limiting the exception to a case-by-case approach might mitigate
concerns about taxpayers being unfairly subjected to an extended
assessment period when they have legitimate offshore transactions. For
example, an exception to the statute could be limited to taxpayers
identified on client lists of known promoters of offshore schemes. This
option might allay concerns about including all taxpayers, particularly
those having legitimate reasons for offshore transactions.
* Maintaining symmetry between the statute for assessments and the
statute for refunds by matching any exception to the statute for
assessments with the same exception to the statute for refunds might
mitigate taxpayer concerns about the unfairness or one-sidedness of an
exception to the statute for assessments. If the statute was suspended
until taxpayers respond to IRS request for records, for example, the
statute for refunds should also be suspended until the taxpayers
respond to the request.
* Assuring access to IRS appeals procedures and to the Tax Court might
mitigate taxpayers' concerns about the potential for IRS abuse as well
as provide due process should they decide to challenge IRS's use of
such an exception to the statute. For example, procedures requiring
TIGTA to investigate any taxpayer allegations of denial of due process
could be mandated.
Conclusions:
As with all forms of tax evasion, it is important that IRS pursue
offshore tax evasion because it adds to the tax gap, increases the tax
burden on honest taxpayers, and poses a threat to the integrity and
fairness of our tax system by adversely affecting voluntary compliance
when honest taxpayers come to believe that other people are getting
away with not paying their fair share. Offshore tax evasion is special,
though, in that the examinations that IRS pursues typically take much
longer to develop and examine because of the inherent difficulty in
identifying and obtaining information from foreign sources, the often
dilatory and uncooperative tactics on the part of taxpayers and their
representatives, and the technical complexity of the examinations.
Nevertheless, the statute of limitations that applies to offshore
examinations is the same as applies to all returns. This leads to some
suspected tax evasion that IRS identifies going unexamined when revenue
agents and managers choose not to start work on offshore examinations
because there is too little time remaining under the statute or choose
to cut work off early in order to avoid a barred statute. There are
exceptions that permit IRS to continue examinations past the 3-year
point and still make assessments, but in many offshore examinations IRS
has only 3 years to complete its work. Furthermore, taking an
examination past the 3-year point in anticipation of finding fraud or
one of the other exceptions permitted under the statute represents a
gamble by IRS that the investment of additional examination resources
will ultimately result in an assessment being allowed under the law.
Past Congresses have recognized the need for statute exceptions in the
face of similar compliance and enforcement obstacles. In the case of
the statute exception for unreported listed transactions, Congress
delegated to IRS the responsibility for defining the specific
circumstances triggering the exception. A statute exception for
offshore examinations that balances the additional layers of difficulty
for IRS in detecting and examining offshore cases with fairness to
taxpayers involved in legitimate offshore financial activity would
strengthen IRS's efforts to combat offshore tax evasion. Additional
time to complete examinations would give IRS greater flexibility in
choosing which examinations to open and when to close them. This would
likely lead to fewer examinations where revenue agents abandon the
pursuit of apparent noncompliance simply because they are running out
of time.
Matter for Congressional Consideration:
In order to provide IRS with additional flexibility in combating
offshore tax evasion schemes, Congress should make an exception to the
3-year civil statute of limitations assessment period for taxpayers
involved in offshore financial activity. Similar to Congress's approach
to unreported listed transactions, Congress may wish to establish a
process wherein IRS would identify the types of offshore activity to
which a statute exception would apply.
Agency Comments and Our Evaluation:
We received e-mail and oral comments from IRS's SB/SE division and the
IRS General Counsel's office about a draft of this report. The
officials making comments noted that a longer statute for offshore
examinations makes sense and should enhance compliance. They also
discussed how the offshore-to-nonoffshore comparisons in the draft of
this report were typically made for all types of examinations, rather
than only of field examinations. They observed that field examinations
are by far the most common type of examination used for offshore tax
evasion cases and suggested that a comparison of just field
examinations would also be useful to the reader. We agreed and we
changed our discussion of offshore-to-nonoffshore examinations to
include comparisons both of all types of examinations collectively and
field examinations alone. Also in their comments, IRS officials
clarified other technical and legal issues, which we incorporated in
this report where appropriate.
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from its issue date. At that time, we will send copies to the Chairman
and Ranking Member, House Committee on Ways and Means; the Secretary of
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If you or your staff have any questions, please contact me at (202) 512-
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Congressional Relations and Public Affairs may be found on the last
page of this report. Key contributors to this report are listed in
appendix II.
Signed by:
Michael Brostek:
Director, Tax Issues Strategic Issues Team:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
The objectives of this report were to (1) compare the length of and
recommended assessments yielded by offshore and nonoffshore
examinations and determine the effect of the 3-year statute of
limitations on recommended offshore assessments, (2) determine whether
or not enforcement problems posed by offshore examinations are similar
to those where Congress has previously granted an exception to the
statute, and (3) identify possible advantages and disadvantages of an
exception to the statute for offshore examinations.
To compare the length of and recommended assessments yielded by
offshore and non-offshore examination cases and determine the effect of
the statute of limitations on offshore assessments, we examined the
Internal Revenue Service (IRS) Audit Information Management System
Reference (AIMS) database, which holds all IRS's data about completed
examinations. The database included a variety of taxpayers, including
individuals, businesses, and corporations, including large
corporations. We analyzed fiscal years 2002 through 2005, the most
recent years for which IRS had data at the time of our evaluation. We
grouped all examinations maintained in the AIMS database by whether
they were offshore examinations (as determined by the project code
under which all examinations are categorized) or not offshore
examinations. We found that there were both offshore and nonoffshore
examinations represented among all of the types of taxpayers in AIMS
with the exception of excise tax examinations, which were only found in
the nonoffshore subset. We used the AIMS data to analyze the number of
days cases spent in both development and examination and the
recommended assessments from both offshore and nonoffshore
examinations. We further subdivided the data to compare only field
examinations, because these were the most common type of offshore
examination. To assess the reliability of the AIMS data, we reviewed
AIMS documentation, and conducted electronic testing of key variables.
Based on this work, we determined that the AIMS data were sufficiently
reliable for our purposes.
We spoke with 17 IRS revenue agents and managers with expertise in the
offshore area about their experience in conducting and closing offshore
examinations. We also examined 12 offshore examination case files to
gain an understanding of the circumstances that IRS revenue agents face
in dealing with noncompliant taxpayers. We spoke with IRS
representatives to gain an understanding of how cases are identified
for examination, and to determine the process by which an offshore case
is developed and examined. In addition, we reviewed various IRS
documents related to the statute of limitations on assessments,
including exceptions to the statute.
To determine whether or not enforcement problems posed by offshore
cases are similar to those where Congress granted an exception to the
statute in the past, we identified enforcement problems posed by
offshore examinations. To do so, we examined IRS's AIMS database,
examined case files and spoke with IRS representatives. We also
identified enforcement problems where Congress granted an exception to
the statute in the past. To do so, we researched the history of the
federal statute of limitations for assessments. We also reviewed
legislation proposed between 2003 and 2006 that included references to
either offshore tax evasion or the statute of limitations. This
included the American Jobs Creation Act of 2006 and other legislative
proposals related to the statute. In addition, we reviewed reports
prepared by the Treasury Inspector General for Tax Administration and
California state agencies related to tax avoidance issues and the
statute. We supplemented these reviews with discussions with
representatives of the California Franchise Tax Board.
To identify advantages and disadvantages of granting an exception to
the statute for offshore examinations, we interviewed representatives
of various organizations to obtain views on mandating an exception to
the statute for offshore examinations. Such an exception would afford
IRS more time to develop and examine offshore examinations. These
organizations included the American Association of Attorney--Certified
Public Accountants, American Bar Association, American Institute of
Certified Public Accountants, National Association of Enrolled Agents,
National Association of Tax Professionals, National Society of
Accountants, and National Society of Tax Professionals. We also
interviewed representatives of various organizations within the
Department of the Treasury to obtain their views. These organizations
included the IRS Small Business/Self Employed division, the Taxpayer
Advocate Service, the IRS Office of Chief Counsel, and the Department
of the Treasury Office of Tax Policy.
[End of section]
Appendix II: GAO Contact and Staff Acknowledgments:
GAO Contact:
Michael Brostek, (202) 512-9110 or brostekm@gao.gov:
Acknowledgments:
In addition to the contact named above, David Lewis, Assistant
Director; Perry Datwyler; Evan Gilman; Shirley Jones; John Mingus; and
Jeff Schmerling made key contributions to this report.
FOOTNOTES
[1] Tax evasion is any method of willfully avoiding or reducing taxes
that is not permitted by law. Tax evasion is distinguished from "tax
avoidance" which denotes the legal interpretation of the tax laws to
legitimately minimize tax liability. In this report, we use the term
"tax evasion" to describe the target of the actions IRS takes to (1)
identify underreported or unreported tax liabilities, either as a
result of tax evasion or abusive transactions or claims subject to
disallowance under existing law, and (2) assess the correct amount of
taxes owed by the taxpayer and any penalties that may apply. Separate
from the assessment of taxes owed by the taxpayer, tax evasion is
itself a crime punishable under IRC 7201.
[2] IRS assigns a "project code" to those examinations whose main
component is offshore tax evasion, and for the purposes of this review,
those case files with one of six offshore project codes are considered
offshore tax evasion.
[3] IRS officials noted that although many enforcement problems occur
in certain foreign jurisdictions that are characterized by strict
financial privacy regimes, the term "offshore" broadly includes the
activities of U.S. taxpayers in all foreign transactions.
[4] Analyses in this report involve recommended assessments at the
close of the examination. Recommended assessment amounts can be reduced
if the taxpayer takes his or her case to IRS Appeals or to Tax Court.
[5] A small number of examinations take an especially short or an
especially long time to develop and complete. Because of this, we
generally use medians in this report as the representation of the
central tendency of the data we analyzed.
[6] Because we chose to count development time for only the return
filed immediately before the examination start date, the median
development time information in table 1 understates development time
for examinations that were in fact prompted by an earlier return from
the same taxpayer. This makes our estimate of development time
conservative for both offshore and nonoffshore examinations.
[7] Direct examination hours are different from total cycle time or
examination days in that they do not include time between actions by
IRS, such as time spent waiting for a response from the taxpayer or
from a financial institution.
[8] The average of direct time charges on nonoffshore field
examinations is affected by a small number of examinations that are
both very time intensive and result in very high recommended
assessments. We used averages in this comparison because hours per
nonoffshore examination are influenced by the large number of very
short correspondence examinations, resulting in a median of only 1 hour
per case.
[9] Other exceptions to the statute are in law. These three exceptions
are specified in this guidance for carrying an examination past the 3-
year statute date without first definitively proving that one of the
statute exception conditions applies. IRS may also continue an
examination past the 3-year point when taxpayers agree to waive their
statute rights.
[10] This exception is limited to just certain transfers associated
with foreign corporations, partnerships and trusts. The exception is
further limited to specific issues related to transactions with these
foreign entities, such as the organization or reorganization of foreign
corporations and the acquisition of their stock.
[11] At the time of our review, IRS had six offshore projects--Credit
Card Summons, Offshore Transactions, Offshore Compliance Initiative
Project, Foreign Trusts, Amended Returns with Offshore Voluntary
Compliance Issues, and the Offshore Compliance Project.
[12] Considering only field examinations, median assessments from
offshore examinations during this period that resulted in an assessment
were very similar--about $17,300 from examinations that took longer
than 3 years and $5,800 from examinations closed in less than 3 years.
For nonoffshore examinations, field examinations that took longer than
3 years had a median recommended assessment of about $14,000 and those
closed within 3 years had a median recommended assessment of about
$3,900.
[13] Survey decisions can be made at several levels of management and
may also be made by individual agents.
[14] GAO, Internal Revenue Service: Enhanced Efforts to Combat Abusive
Tax Schemes--Challenges Remain, GAO-02-618T (Washington, D.C.: Apr. 11,
2002).
[15] Chapter 277, 48 Stat. 683, May 10, 1934.
[16] Chapter 463, 39 Stat. 756, Sept. 8, 1916.
[17] Pub. L. No. 105-34, Aug. 5, 1997.
[18] Listed transactions are the same as, or substantially similar to,
a transaction specifically identified by IRS as a tax avoidance
transaction. For a transaction to be a listed transaction, IRS must
issue a notice, regulation, or other form of published guidance
informing taxpayers of the details of the transaction. IRS listed 31
such transactions as of January 2007.
[19] Pub. L. No. 108-357, Oct. 22, 2004.
[20] Treas. Reg. Sec. 301.6112-1 and Treas. Reg. Sec. 1.6011-4.
[21] Treasury Inspector General for Tax Administration, The Settlement
Initiative for Investors in a Variety of Bond and Option Sales
Strategies Was Successful and Surfaced Possible Next Steps for
Curtailing Abusive Tax Shelters, 2006-30-065 (Washington, D.C.: Mar.
31, 2006).
[22] During 2005, the California FTB formed several new units to reduce
the tax gap. Among these new units was the Abusive Tax Shelter Unit,
which was formed to identify returns with abusive tax shelters and to
foster self-compliance. According to a California FTB manager, this
unit instituted a new approach to addressing potential participants in
abusive transactions. Based on disclosure information, investor lists,
and tax returns, she explained that the unit contacts taxpayers with a
self-compliance letter to solicit amended returns that reverse the
potentially abusive issues.
[23] The California Tax Shelter Resolution Initiative provided
analogous tax treatment for California taxpayers participating in, or
intending to participate in, IRS's Settlement Initiative for an array
of transactions, including 16 listed transactions and 5 other
transactions that IRS considered potentially abusive. Taxpayers had
until January 23, 2006, to submit their settlement applications to IRS.
To participate in the California initiative, California taxpayers must
have participated in the IRS initiative. They had until March 31, 2006,
to file an election to participate in the California initiative. Both
the IRS and California initiative required payment of taxes owed and
interest. Both also provided penalty waivers and allowed transaction
costs such as professional and promoter fees.
[24] House Report 108-548--Pt. 1 American Jobs Creation Act of 2004
(June 2004).
[25] Senate Report 108-11--CARE Act of 2003 (Feb. 27, 2003).
[26] Chase Securities Corp. v. Donaldson, 325 U.S. 304, May 21, 1945.
[27] The Revenue Act of 1919, ch. 18, 40 Stat. 1057, February 24, 1919.
[28] The Revenue Act of 1932, ch. 209, 47 Stat. 169, June 6, 1932.
[29] The Revenue Act of 1934, ch. 277, 48 Stat. 683, May 10 1934.
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