oversight

Internal Revenue Service: Challenges Remain in Combating Abusive Tax Schemes

Published by the Government Accountability Office on 2003-11-19.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                United States General Accounting Office

GAO             Report to the Chairman and Ranking
                Minority Member, Committee on
                Finance, U.S. Senate


November 2003
                INTERNAL REVENUE
                SERVICE
                Challenges Remain in
                Combating Abusive
                Tax Schemes




GAO-04-50
                a
                                                November 2003


                                                INTERNAL REVENUE SERVICE

                                                Challenges Remain in Combating
Highlights of GAO-04-50, a report to the
Chairman and Ranking Minority Member,
                                                Abusive Tax Schemes
Committee on Finance, U.S. Senate




Abusive tax avoidance schemes                   Abusive schemes vary in nature, and new ones continually emerge, making it
could threaten our tax system’s                 very difficult to measure their extent. IRS has been gathering information to
integrity and fairness if honest                better define the scope of abusive schemes. In addition to 131,000
taxpayers believe that significant              participants linked to abusive schemes between October 1, 2001, and mid-
numbers of individuals are not                  August 2003, IRS officials estimated that several hundred thousand others
paying their fair share of taxes.
Abusive schemes encompass such
                                                likely are engaged in abusive schemes. However, IRS documented this
distortions of the tax system as                estimate only when GAO asked. Documentation can help policymakers
falsely describing the law (saying,             judge the appropriateness of IRS resources and strategy in combating the
for example, that the income tax is             high-priority abusive scheme problem.
unconstitutional), misrepresenting
facts (for instance, promoting the              IRS’s broad-based strategy for addressing abusive schemes included:
deduction of personal expenses as
business expenses), or using trusts             •   targeting promoters to head off the proliferation of abusive schemes and
or offshore bank accounts to hide                   to identify taxpayers taking advantage of them;
income.                                         •   offering inducements to taxpayers to come forth and disclose their use
                                                    of questionable offshore tax practices; and
As agreed, this report focuses on
three objectives. They are to
                                                •   using performance indicators to measure outputs and intending to
(1) describe the nature and scope                   continue down the path it has started and develop long-term process and
of abusive tax avoidance schemes                    results-oriented performance goals and measures linked to those goals.
as determined by the Internal                       The lack of these latter elements impedes gauging IRS’s progress in
Revenue Service (IRS), (2) describe                 combating abusive schemes.
IRS’s strategy to combat these
schemes and the performance                     Using a systematic agencywide decision-making process, IRS planned to
goals and measures IRS uses to                  shift significant resources to support its strategy, but the level of resources
track its major effort related to               likely to be used in fiscal year 2003 was less than expected due to overly
them, and (3) describe how IRS                  optimistic workload forecasts caused by inexperience with the types of
determined the amount and source                cases involved. Future resource usage remains to be seen, given uncertainty
of staff resources to be devoted to
these schemes in the IRS operating
                                                about how much abusive scheme work IRS will have and how long it will
division most directly affected.                take to close cases. IRS’s understanding of how many staff will be needed to
                                                address the problem over what period will continue to evolve as IRS gains a
                                                better understanding of the problem’s scope.
                                                Fiscal Year 2003 Examination Full-Time Equivalent Resources Devoted to Abusive Schemes,
GAO recommends that when IRS                    as Originally Planned and as Projected If Pace at July 31, 2003 Continued
prepares future estimates of the
size of the abusive scheme
problem, the Commissioner of
Internal Revenue document the
support underlying the estimates.
In written comments on a draft of
this report, the Commissioner
agreed with this recommendation.


www.gao.gov/cgi-bin/getrpt?GAO-04-50.

To view the full product, including the scope
and methodology, click on the link above.
For more information, contact Michael
Brostek at (202) 512-9110 or
brostekm@gao.gov.
Contents



Letter                                                                                                              1
                         Results in Brief                                                                           2
                         Background                                                                                 4
                         Nature of Abusive Schemes Varies and Their Scope Is Unknown                                5
                         IRS Strategy to Combat Abusive Schemes Is Broad-Based, but Has
                           No Long-term Performance Goals or Measures Linked to
                           Goals                                                                                10
                         IRS Planned Resource Shifts Are Significant, but Resource Use
                           Started Slowly and Future Use Remains to Be Seen                                     15
                         Conclusions                                                                            23
                         Recommendation to the Commissioner of Internal Revenue                                 24
                         Agency Comments                                                                        24


Appendix
           Appendix I:   Comments from the Internal Revenue Service                                             26


Tables                   Table 1: Descriptions of Abusive Scheme Categories                                         6
                         Table 2: Comparison of Different Estimates of the Number of
                                  Taxpayers Involved in Abusive Schemes                                             9
                         Table 3: Planned Shift in Revenue Agent and Tax Compliance
                                  Officer FTE Positions Devoted to Abusive Scheme Priority
                                  Areas, Fiscal Years 2002-2004                                                 17
                         Table 4: Planned and Projected Revenue Agent and Tax
                                  Compliance Officer FTEs Devoted to Abusive Scheme
                                  Priority Areas, Fiscal Year 2003                                              20
                         Table 5: Comparisons of Inventory Developments with Inventory
                                  Expectations                                                                  21




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                         Page i                           GAO-04-50 Challenges in Combating Abusive Tax Schemes
A
United States General Accounting Office
Washington, D.C. 20548



                                    November 19, 2003                                                                   Leter




                                    The Honorable Charles E. Grassley
                                    Chairman
                                    The Honorable Max Baucus
                                    Ranking Minority Member
                                    Committee on Finance
                                    United States Senate

                                    Abusive tax schemes encompass such distortions of the tax system as
                                    falsely describing the law (saying, for example, that the income tax is
                                    unconstitutional), misrepresenting facts (for instance, promoting the
                                    deduction of personal expenses as business expenses), or using trusts or
                                    offshore bank accounts to hide income. During an April 2002 hearing
                                    before the Senate Committee on Finance, we testified about the inexact
                                    process for estimating the extent of abusive schemes used by individual
                                    taxpayers.1 We pointed to Internal Revenue Service (IRS) estimates that
                                    about 740,000 taxpayers had used certain types of abusive schemes in tax
                                    year 2000, and that $20 billion to $40 billion in improper tax avoidance or
                                    tax credit and refund claims had occurred that IRS had not yet been able to
                                    identify and address. We noted that abusive schemes could threaten our tax
                                    system’s integrity and fairness if honest taxpayers believe that significant
                                    numbers of individuals are not paying their fair share of taxes.

                                    The estimated 740,000 taxpayers consisted of estimates of the number of
                                    taxpayers in four major scheme areas--about 62,000 with frivolous returns,
                                    105,000 with frivolous refunds, 65,000 using abusive domestic trusts, and
                                    505,000 using offshore schemes. Of the 505,000 taxpayers estimated to use
                                    offshore schemes, IRS estimated 500,000 were abusing offshore credit
                                    cards. In our testimony, we discussed how IRS arrived at its estimates. We
                                    also understand that some of the estimates reflected high-end numbers, for
                                    example, the numbers of taxpayers who were associated with a particular
                                    abusive promoter, but not necessarily reflecting an abusive scheme on their
                                    tax returns.

                                    The $20 billion to $40 billion estimate of taxes not identified and addressed
                                    related to offshore schemes. Saying there were no reliable data to predict



                                    1
                                     U.S. General Accounting Office, Internal Revenue Service: Enhanced Efforts to Combat
                                    Abusive Tax Schemes—Challenges Remain, GAO-02-618T (Washington, D.C.: Apr. 11, 2002).




                                    Page 1                         GAO-04-50 Challenges in Combating Abusive Tax Schemes
                   tax implications, IRS derived its estimate based on average dollars in other
                   parts of the abusive tax scheme program.

                   As agreed, this report focuses on three objectives. They are to (1) describe
                   the nature and scope of abusive tax avoidance schemes as determined by
                   IRS, (2) describe IRS’s strategy to combat these schemes and the
                   performance goals and measures IRS uses to track its major effort related
                   to them, and (3) describe how IRS determined the amount and source of
                   staff resources to be devoted to these schemes in the IRS operating division
                   most directly affected. To do our work, we (1) analyzed IRS and other
                   scheme reports, publications, data, and other documentation providing
                   insight into the characteristics, complexity, size, and type of the problem,
                   (2) reviewed IRS planning documents with information on IRS strategies,
                   measures, milestones, and resources, (3) compared the contents of IRS
                   planning documents to Government Performance and Results Act of 19932
                   (GPRA) criteria on what elements strategic planning should include, and
                   (4) interviewed agency officials about their views on, among other things,
                   the problem’s nature and scope and IRS’s strategy. We did our work from
                   September 2002 through September 2003 in accordance with generally
                   accepted government auditing standards.



Results in Brief   Abusive schemes vary in nature, and new ones continually emerge, making
                   it very difficult to measure their extent. IRS has been gathering information
                   to better define the scope of abusive schemes. In addition to 131,000
                   participants who were linked to abusive schemes between October 1, 2001,
                   and mid-August 2003, IRS officials estimated that several hundred
                   thousand additional taxpayers likely are engaged in abusive schemes.
                   Officials have not estimated how many tax dollars might be involved
                   overall. IRS’s estimate of those involved is primarily based on promoter-
                   related information developed in the past year and includes only those
                   offshore credit card cases where IRS believes individuals’ names are likely
                   to be identified. Although they did not originally have documentation
                   supporting this estimate, upon request, IRS officials prepared
                   documentation for us showing the estimate’s derivation. Documenting the
                   basis for key program-related numbers ensures that others can judge their
                   reliability and better understand what may account for differences in such
                   key numbers over time. IRS continues to believe abusive schemes


                   2
                   P.L. 103-62.




                   Page 2                      GAO-04-50 Challenges in Combating Abusive Tax Schemes
represent a significant compliance problem that deserves considerable
attention, and schemes remain a top enforcement priority.

IRS’s broad-based strategy for addressing abusive schemes included the
following:

• targeting promoters to head off the proliferation of abusive schemes and
  to identify taxpayers taking advantage of them;

• offering inducements to taxpayers to come forth and disclose their use
  of questionable offshore tax practices;

• focusing attention on identifying schemes, alerting the public, and
  enforcing the law, including partnering with states to share information
  on abusive schemes;

• promoting the coordination of efforts throughout IRS; and

• using performance indicators to measure outputs and intending to
  continue down the path it has started and develop long-term process
  and results-oriented performance goals and measures linked to those
  goals. The lack of these latter elements impedes gauging IRS’s progress
  in combating abusive schemes.

IRS is in the midst of its efforts to implement its abusive scheme strategy
and has had to make decisions about staff allocations and what can be
accomplished on the basis of available information. Using a systematic
agencywide decision-making process, IRS planned to shift resources,
significantly in the case of examination resources, to support its strategy,
but the level of resources used in fiscal year 2003 through July 31 and likely
to be used in fiscal year 2003 as a whole was less than expected due to
overly optimistic workload forecasts caused by inexperience with the types
of cases involved. The extent to which the caseload and resources will
match each other in the future remains to be seen, given the uncertainty
about the volume of additional work and the rate at which IRS can close
abusive scheme examinations. IRS’s understanding of how many staff will
be needed to address the program and how long staff will take to work
through the cases will continue to evolve as IRS gains a better
understanding of the scope of abusive schemes.




Page 3                       GAO-04-50 Challenges in Combating Abusive Tax Schemes
             To ensure that support for future IRS estimates of the size of the abusive
             scheme problem exists, we are recommending that IRS document the
             support when preparing the estimates.

             In written comments, the Commissioner of Internal Revenue agreed with a
             draft of this report. He specifically agreed with the recommendation and
             said that IRS would establish a methodology for documenting the basis for
             the estimates. He also affirmed IRS’s intention to establish measurable
             process and results-oriented goals and said that developing these measures
             is an operational priority for fiscal year 2004.



Background   In a June 2002 letter, the Secretary of the Treasury addressed various
             questions posed by the then Ranking Member of the Committee on Finance
             on IRS actions to address abusive schemes. Treasury’s letter pointed to
             IRS’s Small Business/Self-Employed (SB/SE) Division as having primary
             responsibility for abusive schemes marketed to individuals and small
             businesses.

             Within SB/SE, several units have established combating abusive schemes
             as a top priority. The Office of Reporting Enforcement was established in
             2002 to increase program oversight and to help information flow among
             programs that address abusive schemes. SB/SE’s collection component is
             to work closely with the examination function to ensure coordination. Its
             Taxpayer Education and Communication unit has launched a
             countermarketing strategy against abusive tax schemes and their
             promoters. Its Communications and Liaison unit is responsible for
             developing communication messages and strategies to maintain and
             enhance ongoing IRS interaction with internal and external stakeholders.

             Other IRS organizations are also involved with abusive schemes. For
             instance, Criminal Investigation (CI) works closely with SB/SE and
             investigates and pursues promoters and individuals using schemes. The
             Office of Chief Counsel provides legal services, such as publishing
             guidance, working with examination and collection activities, and pursuing
             litigation.




             Page 4                      GAO-04-50 Challenges in Combating Abusive Tax Schemes
Nature of Abusive          The nature of abusive tax schemes is both varied and evolving. We testified
                           last year that as schemes are often hidden, estimates presented in 2002 of
Schemes Varies and         the extent of abusive tax avoidance were inexact at best. IRS efforts
Their Scope Is             underway to more definitively identify the scope of the problem revealed
                           that, for the period from October 1, 2001, until mid-August 2003, 131,000
Unknown                    participants were involved in abusive schemes. For the 72,600 of these
                           participants identified by February 28, 2003, IRS estimated that about
                           $1.6 billion in taxes were or might be recaptured, with more to be
                           determined. In addition, on the basis of the number of promoters identified
                           and the amount of information not yet received or processed, IRS officials
                           estimated that hundreds of thousands of other taxpayers were involved in
                           abusive schemes, but they did not prepare supporting documentation when
                           making the estimate. According to IRS, recent estimates resulted from
                           knowledge gained over the last year focusing on more specific information
                           than previously used.



Abusive Schemes Vary and   Abusive schemes include various kinds of arrangements designed to
New Ones Continually       circumvent tax laws or evade taxes. As we testified last year, they can run
                           from very simple to very complex, from clearly illegal to those carefully
Emerge                     constructed to disguise the illegality of the scheme. Users of schemes can
                           range from those believing their position is correct to those who knowingly
                           but willfully file incorrect tax returns.

                           As shown in table 1, SB/SE sorts abusive schemes into seven categories.
                           They range from trust arrangements to those claiming no legal basis for
                           federal income taxes to tax shelters bought by taxpayers that are under
                           SB/SE’s auspices. In the case of the latter, SB/SE is responsible for
                           investigating abusive shelters used by high-wealth individuals with
                           complex tax returns and by businesses with assets of less than $10 million.




                           Page 5                      GAO-04-50 Challenges in Combating Abusive Tax Schemes
                           Table 1: Descriptions of Abusive Scheme Categories

                           Category of scheme                  Description of the category
                           Abusive trust schemes               Arrangements featuring layers of trusts, with each trust
                                                               distributing income to the next layer to fraudulently reduce
                                                               taxable income to nominal amounts
                           Deduction/expense                   False representations of facts to claim improper deductions
                           schemes
                           Refund/credit schemes Schemes involving the creation of credits to substantially reduce
                                                 tax or create refunds
                           Antitax arguments                   Arguments that entice people to believe collecting federal
                                                               income taxes has no legal basis
                           Exempt organization                 Schemes using a tax-exempt entity to obtain unallowable
                           schemes                             benefits
                           Tax shelters                        Very complicated transactions that sophisticated tax
                                                               professionals promote, exploiting tax loopholes and reaping
                                                               large and unintended tax benefits
                           Offshore compliance                 Schemes in which the true ownership of income streams and
                           schemes                             assets is hidden to improperly shield financial activity from the
                                                               U.S. tax system
                           Source: IRS data compiled by GAO.


                           According to IRS officials, the popularity of schemes can also vary.
                           Officials have seen a decline in slavery reparation schemes over time, and
                           they have also become aware of new schemes that abuse corporate “soles”
                           (one-member religious entities used to claim that income is tax free) and
                           the disabled access credit (used to reduce taxes or create refunds). One
                           SB/SE official explained that scheme promoters try to stay in the business
                           of tax avoidance; when one type of scheme is discovered and addressed,
                           another scheme will take its place.



Scope of Abusive Schemes   The full scope of the abusive tax scheme problem is unknown because
Is Unknown                 estimates are difficult to make based on imperfect data. As we testified last
                           year, estimating the extent of abusive schemes used by individual
                           taxpayers is at best an inexact process because these schemes are often
                           hidden.

                           In fiscal year 2003, SB/SE tried a new approach to improve its information
                           about the problem and help with its work planning process. The new
                           approach differed from prior efforts in that it focused on what IRS had
                           actually found. The effort’s aim was to develop an inventory of abusive
                           schemes and related data in order to develop an overall strategy for


                           Page 6                                      GAO-04-50 Challenges in Combating Abusive Tax Schemes
addressing abusive schemes and to enhance the work planning process. In
this context, SB/SE developed a template for organizing information about
known schemes and known investors. The template took the form of a
matrix to be used to compare the risks presented by various schemes along
the lines of factors such as the number of cases available for IRS staff to
review but as yet unstarted, the number of promoters, the amount of
money involved, and the number of taxpayers participating. The matrix
organizes abusive schemes within the seven categories shown above in
table 1.

According to a summary of items in the matrix categories and IRS’s work
with offshore credit cards covering October 2001 through mid-August 2003,
IRS identified about 131,000 participants in abusive schemes. This number
included 22,000 participants in the offshore credit card area and, according
to SB/SE, reflected the best available data, but not a potential universe. It
updated a previous summary covering October 1, 2001, through February
2003 that showed 72,600 potential participants. In that summary, SB/SE
noted that recaptured or potentially recaptured taxes from closed or
identified reviews totaled almost $1.6 billion, excluding undetermined
amounts from the credit card work. That summary also included the 22,000
participants in the offshore area, but IRS was not able to update this figure
for its later summary because new credit card information had just arrived.

IRS used an estimate in its fiscal year 2005 budget presentation of the
number of taxpayers it believes are involved in abusive schemes who are
likely to be identified through its various efforts. IRS estimated that more
than 400,000 taxpayers fall into this category, generally including the
approximately 131,000 participants it had identified as of mid-August 2003.
According to IRS officials, this estimate was included in materials provided
to the Department of the Treasury and the Office of Management and
Budget during budget discussions. It was used not as a basis for requesting
resources sufficient to examine the taxpayers, but to show that the abusive
scheme problem was large relative to current resources. According to IRS
officials, this estimate was developed during a series of meetings, but
documentation showing the basis for the estimate was not prepared at that
time.

We are unaware of a specific IRS or other policy that requires
contemporaneous documentation of a figure like the 400,000 estimate of
taxpayers IRS expects to identify as engaged in abusive schemes.
Nevertheless, documenting the basis for key numbers related to an
agency’s programmatic efforts is in line with the thrust of management



Page 7                      GAO-04-50 Challenges in Combating Abusive Tax Schemes
legislation and IRS’s own policies. For example, GPRA stresses not only
that agencies develop measures of program performance, but also that the
measures be valid and reliable. IRS too stresses that program managers
have valid and reliable measures of program performance in its Strategic
Planning, Budgeting, and Performance Management Process. Although the
400,000 estimate is not an IRS program performance measure, it is a
measure that IRS has used in discussions on its fiscal year 2005 budget
needs. Further, Congress has expressed interest in the specific issue of
abusive schemes, including through this review, which has focused in part
on the nature and scope of abusive tax schemes. Documenting the basis for
key program-related numbers ensures that others can judge their reliability
and better understand what may account for differences in such key
numbers over time.

At our request, IRS prepared a document showing how the estimate of over
400,000 was derived. IRS based this estimate to a great extent on the
promoters it had identified, but for which it had not yet received investor
lists. If each investor list contained only the average number of names
identified on the very few lists considered so far, a conservative
assumption according to SB/SE’s Deputy Director, Compliance Policy,
more than 300,000 taxpayers would be involved. In addition, although IRS
had not yet processed most of the offshore credit card information it had
received, staff projected that tens of thousands of abusive credit card users
were likely to be identified. According to the same official, IRS now
believes more taxpayers are engaged in various abusive schemes not
involving offshore credit cards than it did last year but fewer than it
believed last year are engaged in schemes involving offshore credit cards
and likely to be identified. Not wanting to overstate the total number of
taxpayers likely to be identified as involved in abusive schemes, IRS
adopted a conservative estimate of more than 400,000, emphasizing to us
that its program is still in the developmental stage and the number is
probably higher. Table 2 compares how the 400,000 relates to the numbers
used in our testimony from last year. Because some of the numbers are
estimates based on limited information and because the specific types of
cases included in the different categories are not always identical, the
comparisons are only a general indication of changes in the potential size
of the scheme categories and the total number of taxpayers involved.




Page 8                      GAO-04-50 Challenges in Combating Abusive Tax Schemes
Table 2: Comparison of Different Estimates of the Number of Taxpayers Involved in
Abusive Schemes

Scheme areaa                                 February 2002 estimate October 2003 estimate
Offshore credit cards and other                                 570,000          More than 400,000
schemes
Frivolous returns                                                62,000                       21,000b
Frivolous refunds                                               105,000                     127,000b
Total                                                          737,000          More than 548,000
Source: Derived by GAO from IRS data.
a
 The types of schemes included in the different categories in the two periods were not consistent, but
the differences were small relative to the total number of taxpayers involved.
b
These numbers are for fiscal year 2002.


IRS has not associated a dollar amount with its estimate of more than
400,000 taxpayers, although it believes the amount is substantial.
According to SB/SE’s Deputy Director, Compliance Policy, IRS is trying to
be more data-driven in this area and is not tracking dollars associated with
its projection.

In addition to the estimate of more than 400,000 taxpayers, some IRS units
collected other information regarding abusive schemes that identified the
scope of other pieces of the problem. These pieces are not part of SB/SE’s
examination workload planning effort because they do not involve
examinations. IRS’s Frivolous Return Program identifies returns and
refunds for taxpayers whose returns either state an argument that IRS can
readily identify as frivolous or have characteristics IRS has identified as
reflecting a frivolous argument. The program stopped about 21,000
frivolous returns (as shown in table 2) and refunds resulting in about
$619 million in protected tax dollars in fiscal year 2002. CI identified about
127,000 fraudulent refund claims in fiscal year 2002 and stopped about
$379 million in fraudulent refunds.




Page 9                                  GAO-04-50 Challenges in Combating Abusive Tax Schemes
IRS Strategy to Combat      IRS’s abusive scheme strategy takes a multipart approach to focus
                            resources on the most egregious promoters of, and participants in, offshore
Abusive Schemes Is          credit card and other schemes. It entails identifying schemes and their
Broad-Based, but Has        participants, alerting the public, enforcing the law, and coordinating efforts
                            internally and throughout IRS. Although IRS planning documents outline
No Long-term                an overall strategy for combating abusive schemes, IRS has not yet defined
Performance Goals or        long-term performance goals for the effort and the measures it would use
Measures Linked to          to track progress in achieving those goals. However, although establishing
                            such goals and measures will be challenging, IRS intends to establish
Goals                       process and results-oriented goals in the future.3



SB/SE’s Strategy Includes   As outlined in planning documents, the SB/SE strategy to combat abusive
Pursuing Egregious          tax schemes focuses on attacking the source of what IRS considers to be
                            the most egregious abusive noncompliance. The strategy requires using
Promoters As Well As
                            scarce resources to address three high-priority areas—promoters, offshore
Offshore Credit Card and    credit card schemes, and other abusive schemes (including offshore
Other Abusers               schemes other than credit card schemes)—all under the jurisdiction of a
                            position established in 2002, the Director of Reporting Enforcement.

                            Because promoters generate noncompliance by selling tax avoidance
                            schemes to others, they represent a top priority in the strategy. By pursuing
                            promoters, IRS may leverage its resources and gain access to lists of clients
                            who bought the promoters’ products. An SB/SE official stated that the
                            focus is to pursue promoters first to stop the growth of abusive schemes.
                            IRS can then take enforcement actions against participants in abusive
                            schemes.

                            IRS especially targeted abusive schemes involving credit cards issued by
                            offshore banks. Credit cards allow easy access to income hidden in
                            accounts in tax haven countries. In October 2000, IRS issued summonses to
                            two credit card companies to obtain limited information about U.S. citizens
                            holding credit cards issued by banks in three offshore financial centers.


                            3
                             Guidance related to GPRA can provide a framework in developing measurable goals and
                            outcome-oriented measures. Although GPRA is generally applied to agencywide strategic
                            plans, its framework is useful to guide any type of planning. GPRA requires long-term
                            strategic and annual performance goals and associated measures, preferring measures
                            relating to outcomes (results) versus outputs (activities). Office of Management and Budget
                            guidance says that strategic plans set out long-term goals, outlining planned
                            accomplishments and their implementation schedule.




                            Page 10                           GAO-04-50 Challenges in Combating Abusive Tax Schemes
After lengthy negotiations to address one of the company’s concerns and
reach a compromise for compliance, that company provided information in
April 2002. In March and August 2002, IRS issued a second round of
summonses to credit card companies seeking records on cards issued by
banks in 31 offshore financial centers. The scope of records to be produced
under these summonses had to be negotiated, with consideration given to
the burden of requiring full compliance, the balance between the amount of
information to be produced and the time needed to produce it, and the
need to focus as much as possible on probable U.S. taxpayers.

Because IRS could not always identify individuals based on credit card
company information, it also issued summonses to 123 merchants for
additional information that could be used in examinations and criminal
investigations. Analyzing merchant responses was very time consuming,
requiring follow-up for more information, and IRS still needed to work
beyond the merchant information provided to identify taxpayers.

On July 30, 2003, IRS announced that as a result of its credit card project, it
had continuing or completed audits on 2,800 returns, and it had assessed
more than $3 million in taxes. As of early August 2003, IRS had received
records from both rounds of credit card company summonses and from
almost all of the merchant summonses. It needed to go through these
records before it would begin to have a better idea of the size of the credit
card problem, keeping in mind that the merchant summonses related only
to merchants identified by analyzing data produced by one credit card
company responding to the first summons.




Page 11                      GAO-04-50 Challenges in Combating Abusive Tax Schemes
In January 2003, IRS began a voluntary compliance initiative to identify
promoters and to return to tax law compliance taxpayers who use offshore
payment cards to hide income. Under the initiative, eligible taxpayers
stepping forward before April 16, 2003, would not pay certain penalties and
would not face criminal prosecution, pending acceptance into the program.
However, they would agree to provide full details on promoters of offshore
arrangements. They would also pay previously owed taxes, interest, and
certain other penalties. In addition to this voluntary compliance initiative
and to the summonses, the Department of the Treasury has entered into tax
information exchange agreements with offshore financial centers to further
improve the federal government’s information collection.4

On July 30, 2003, IRS announced that 1,299 taxpayers stepped forward to
participate in the voluntary compliance initiative, and that analyzing cases
to date revealed 214 new offshore promoters. According to SB/SE’s Deputy
Director, Compliance Policy, as of mid-September 2003, the initiative had
led to collecting more than $100 million in tax, a figure that continues to
grow. The 1,299 taxpayers who volunteered is a small number compared to
early reports of the scope of the problem. However, according to IRS
officials, the reality of promoters being identified by taxpayers gives IRS
data on the source of the problem and a wealth of information that can be
used to further investigate abusive schemes. They said IRS was in the early
stages of receiving and following up on completed packages of
information, but it had already received valuable information on how
promoted schemes worked. In addition, instead of stepping forward, IRS
officials say some taxpayers seem to have filed amended tax returns,
bringing themselves into compliance in a different way. IRS did not yet
know the number of amended returns that arrived as a result of the
initiative.

For the abusive schemes shown in table 1, SB/SE’s fiscal year 2003 plans
called for developing an inventory of schemes and their status, working out
a more detailed overall strategy, and developing and implementing a
process to oversee and manage IRS’s efforts to combat abusive schemes
and promoters. In general, SB/SE officials saw fiscal year 2003 as a
transition year in which to build an infrastructure for full implementation
of a strategy in fiscal year 2004. To develop inventory information, SB/SE


4
 Between November 2001 and November 2002, Treasury entered into agreements with the
Cayman Islands, Antigua and Barbuda, The Bahamas, the British Virgin Islands, the
Netherlands Antilles, Guernsey, the Isle of Man, and Jersey.




Page 12                        GAO-04-50 Challenges in Combating Abusive Tax Schemes
                            has been devising a matrix to assess the risk associated with various
                            abusive schemes. Although it will not identify the full scope of the problem,
                            the matrix is intended to help SB/SE management prioritize the various
                            schemes it encounters and decide how much in resources to allocate to
                            combat each one.



SB/SE’s Strategy Includes   SB/SE’s strategy to combat abusive schemes includes actions to identify
Identifying Schemes,        schemes, alert the public, and identify and take enforcement action against
                            promoters and participants. SB/SE identifies promoters and participants
Alerting the Public, and    through disclosure initiatives, Internet research, investigations, and
Enforcing the Law           examinations. IRS is also partnering with state tax agencies to combat
                            abusive schemes. On September 16, 2003, IRS announced agreements to,
                            among other things, exchange information about abusive schemes
                            identified at the federal and state levels, have IRS provide leads on
                            participants in abusive schemes to states for investigation, and partner on
                            training and other educational activities.

                            SB/SE’s strategy to alert the public includes targeting educational outreach
                            and countermarketing strategies to address abusive schemes and their
                            promoters. The division’s Taxpayer Education and Communication (TEC)
                            unit, in conjunction with the Communications and Liaison and Reporting
                            Enforcement units and others, created toolkits for abusive scheme
                            outreach and education. The toolkits are for external stakeholders, such as
                            professional organizations, to educate their members and clients and also
                            for use as internal guidance.

                            Enforcement action against promoters and participants can take many
                            forms. For example, IRS criminal investigations can lead to indictments
                            and convictions. Similarly, IRS conclusions that injunctions are warranted
                            can lead to promoters being enjoined from continuing with their
                            promotions. As of May 2, 2003, IRS had 464 ongoing criminal investigations
                            of scheme promoters and investors, as opposed to 125 in 2001, and 27
                            promoter injunctions granted, compared to 1 about a year earlier. IRS can
                            also assert civil penalties or use summonses.



SB/SE’s Strategy Is         Internal coordination is key to SB/SE’s approach for addressing abusive
Coordinated within SB/SE    schemes. Last year we testified that SB/SE was reorganizing to place its key
                            efforts to combat abusive schemes under one executive and better
and throughout IRS          integrate them. Now SB/SE’s Deputy Director, Compliance Policy, is
                            charged with coordinating the division’s strategy for combating abusive


                            Page 13                     GAO-04-50 Challenges in Combating Abusive Tax Schemes
                           schemes and working closely with other IRS operating divisions. IRS has
                           also established coordination groups, namely the Abusive Tax Evasion,
                           Avoidance Schemes, and Devices Executive Steering Committee and the
                           Offshore Credit Card Project Oversight Board, both of which include
                           members from different parts of IRS and operate under the auspices of
                           IRS’s Enforcement Committee chartered in July 2003. Chaired by the
                           Deputy Commissioner for Services and Enforcement, the Enforcement
                           Committee is to guide IRS-wide enforcement strategies, focusing on high
                           visibility issues involving many divisions or potentially having significant
                           compliance impact.

                           IRS units coordinate with each other in various ways in planning and
                           implementing actions to combat abusive schemes. For example, in April
                           2002, SB/SE established the Lead Development Center (LDC) to centralize
                           the nationwide receipt of leads on promoters of abusive schemes. Once the
                           LDC organizes promoter information from both agencywide and external
                           sources, it coordinates with CI to determine who takes the lead in
                           promoter cases of interest to SB/SE and CI and at times to work in parallel
                           investigations. Another example of two divisions partnering with each
                           other was the plan for SB/SE and the Large and Mid-Size Business Division
                           to jointly find ways to identify entities used to mask questionable
                           transactions and address their abuse. As part of this effort, the two
                           divisions planned to develop and implement a strategy to focus on high-
                           income taxpayers investing in flow-through entities used to hide taxable
                           income. The planning documents of different IRS divisions had cross-
                           references to the plans and work of other divisions.

                           SB/SE also coordinates internally and with other units in its efforts to alert
                           the public. TEC and the SB/SE Communications and Liaison unit
                           coordinate with SB/SE Compliance and with CI and the Office of Chief
                           Counsel when doing outreach and education. For instance, Counsel
                           provides legal assistance with language to try to ensure that public
                           messages are legally accurate. As another example, Communications and
                           Liaison, Compliance, CI, and Counsel personnel all provided TEC with
                           input on components of the toolkits TEC developed.



SB/SE Has No Long-term     Although IRS has outlined and begun to implement a strategy for
Performance Goals or       combating abusive schemes, it has not yet defined performance goals for
                           the effort and established the measures it would use to track progress in
Measures Linked to Goals
                           achieving those goals. Performance goals define what an organization is
                           trying to achieve over time, preferably focusing on the outcome desired



                           Page 14                      GAO-04-50 Challenges in Combating Abusive Tax Schemes
                          rather than on activities or outputs. IRS officials recognize that developing
                          performance goals and associated measures to track progress is desirable.
                          Although given the substantial difficulty in assessing the scope of the
                          abusive scheme problem, establishing performance goals and associated
                          measures will be challenging, IRS intends to establish process or results-
                          oriented performance goals in the future.

                          Using business plans and status reports, SB/SE established some short-
                          term goals and measures to track its abusive scheme activity. It established
                          short-term goals, such as developing alternative treatments and/or a
                          settlement strategy for offshore credit card cases by November 1, 2002. (As
                          mentioned earlier, IRS actually began its offshore voluntary compliance
                          initiative in January 2003.) SB/SE also used measures, such as the number
                          of approved investigations. Although establishing these goals and measures
                          represents progress, IRS has not developed long-term process and results-
                          oriented performance goals or measures associated with them.

                          SB/SE officials acknowledged the importance of goals and measures and
                          are working on improving. As mentioned earlier, one of SB/SE’s fiscal year
                          2003 efforts was to develop a detailed overall strategy for addressing the
                          abusive schemes described in table 1, including a process to oversee and
                          manage the area. SB/SE officials said they would devise measures of
                          compliance success once they have their process in hand and gain
                          experience. Because the extent of abusive scheme activity is unknown and
                          success in addressing it is hard to define, efforts to develop long-term
                          performance goals and associated measures are difficult. However,
                          consistent with their ongoing efforts to build an infrastructure to address
                          abusive schemes, SB/SE management officials expressed their intention to
                          establish process and results-oriented goals and measures in the future.
                          Progress in developing these elements is crucial to being able to
                          communicate progress made in combating abusive schemes.



IRS Planned Resource      IRS has begun shifting, although more slowly than expected, and plans to
                          continue shifting, significant resources into addressing abusive schemes,
Shifts Are Significant,   but the potential volume of additional work that may be identified and
but Resource Use          inexperience with the rate at which staff can close cases make it unclear
                          whether the additional resources and the caseloads will match each other.
Started Slowly and        At the agencywide level, IRS used a systematic decision-making process in
Future Use Remains to     deciding to make these shifts. At the SB/SE level, executives considered
Be Seen                   resources available and program priorities in significantly increasing SB/SE
                          examination staff resources devoted to abusive schemes. In doing so, they



                          Page 15                     GAO-04-50 Challenges in Combating Abusive Tax Schemes
                            planned to shift resources out of examining areas such as small
                            corporations and nonabusive flow-through entities.



Overall Budget Trade-offs   IRS decided staffing resource levels to be devoted to addressing abusive
                            schemes through a systematic planning and budgeting process, albeit one
                            that used participants’ experience and judgment in the absence of
                            definitive measures of the problem’s size. Early in calendar year 2002, IRS’s
                            divisions, including SB/SE, conducted strategic assessments in which they
                            studied trends, issues, and priorities affecting their operations. In April
                            2002, IRS’s senior management team, including the Commissioner, Deputy
                            Commissioner, division heads, and others, went through two rounds of
                            considering IRS’s programs to prioritize the needs for new or redirected
                            funding for fiscal year 2004. Of 33 programs considered, abusive schemes
                            received the second most votes. According to an IRS official, this process
                            also informed how funds already requested for fiscal year 2003 would
                            actually be spent.

                            After the senior management team reached consensus, the Commissioner
                            issued overall planning guidance for fiscal years 2003 and 2004 to reflect
                            the jointly set strategic direction, and the divisions wrote fiscal year 2003
                            and 2004 “strategy and program plans” outlining staff resources needed.
                            Showing its intent to focus resources on detecting noncompliance, SB/SE’s
                            plan cited an increasing number of abusive schemes, an abusive scheme
                            estimate of up to $40 billion, promoters using the Internet as their primary
                            way of operating, and the potential for abusive schemes eroding taxpayers’
                            confidence in the tax system’s fairness.



SB/SE Used Priorities to    For fiscal years 2003 and 2004, SB/SE significantly increased the
Plan for Significant        examination resources it planned to allocate to new priorities, including
                            three of its highest: (1) promoters of abusive schemes, (2) offshore credit
Resource Shift
                            card schemes, and (3) other abusive schemes. As shown in table 3, the
                            planned level of resources for these three areas almost quadrupled from
                            267 full-time equivalents (FTE) in fiscal year 2002 to 1,020 FTEs the next
                            year, and it increased slightly from there to 1,154 FTEs for fiscal year 2004.




                            Page 16                      GAO-04-50 Challenges in Combating Abusive Tax Schemes
Table 3: Planned Shift in Revenue Agent and Tax Compliance Officer FTE Positions
Devoted to Abusive Scheme Priority Areas, Fiscal Years 2002-2004

                                              FY         FY       FY     Percentage increase
Priority area                               2002       2003     2004    from FY 2002 to 2004
Promoters of abusive schemes                   16       150      154                      863%
Offshore credit card schemes                    0       561      367                              -
Other abusive schemes                         251       309      633                      152%
Total                                         267     1,020    1,154                      332%
Source: IRS data compiled by GAO.

Note: These FTEs include revenue agents and tax compliance officers, but not tax examiners who
conduct examinations through correspondence. Revenue agents and tax compliance officers usually
have accounting experience and meet directly with taxpayers during the audit. Correspondence
examinations do not require tax examiners to meet with the taxpayer in person.


SB/SE arrived at its fiscal year 2003 budget estimates for different
categories of abusive schemes in different ways. To estimate the number of
examiner FTEs needed for promoters, it started with the number of
approved promoter investigations and assumed another 35 investigations
would be added each month. It also assumed that each investigation would
take 37.5 hours per month for 8 months, for a total of 300 hours.

For offshore credit card schemes, SB/SE estimated a potential number of
participants by extrapolating data from October 2000 summonses to find
potential credit card abusers. It decided how many participants it could
actually examine, which was significantly less than the number of
participants extrapolated, based on the estimated availability of FTEs.

For other abusive schemes, SB/SE estimated a potential number of
participants by using available data on identified schemes and investor
lists. It determined how many hours examining relevant returns would take
by assuming that closing other abusive cases would take certain
percentages of the time needed for nonabusive returns. Although other
abusive schemes evolve and past experience will not necessarily bear out
for the future, for its staff year estimates for other abusive schemes IRS
officials generally had more relevant experience from prior work on
abusive schemes to draw upon than they did for promoter and offshore
credit card staff year estimates.




Page 17                             GAO-04-50 Challenges in Combating Abusive Tax Schemes
In determining its budget estimates for all these areas, SB/SE considered
the allocation to other programs. It did this using input from SB/SE
executives and examiners in an iterative process. Given the shifts to
abusive schemes, SB/SE planned to limit the numbers of its traditional
examinations, such as those of small corporations and nonabusive flow-
through entities. For instance, it scheduled the number of revenue agent
FTEs devoted to nonabusive flow-through entities to decline from 485 to
176 between fiscal years 2002 and 2003, translating to a decrease in the
number of returns examined by revenue agents from 12,318 to 1,078.5
Further, for fiscal year 2003, SB/SE also began directing its most skilled
examination resources away from national programs, such as claims for
refunds and cases with tax returns identified as being most likely to have
their taxes increased upon audit. To cope with this shift in resources away
from certain areas, IRS planned various mitigating efforts, such as first
examining individuals for abusive schemes and then pinpointing related
flow-through and other entities to be audited, rather than first selecting the
entities to audit. We did not assess how the shifts in resources would affect
examination coverage in the areas losing staff or IRS’s plans to mitigate
that effect.

In addition to the increased resources for IRS examination priority areas
reflected in table 3, other parts of SB/SE and IRS also used or planned to
use FTEs to address abusive schemes. For instance, within SB/SE, although
the TEC unit did not specifically allocate FTEs for abusive schemes in
fiscal year 2002, it planned to devote 54 FTEs to addressing abusive
schemes in fiscal year 2003 (about 13 had been used as of July 26, 2003) and
asked for another 125 for fiscal year 2004. Similarly, the collection function
went from 0 FTEs in fiscal year 2002 to planning for 73 and 81 FTEs in fiscal
years 2003 and 2004, respectively. According to an SB/SE official in early
August 2003, SB/SE did not have reliable information on how many FTEs
the collection function had used to date to address abusive schemes in
fiscal year 2003.

Outside SB/SE, although CI did not budget staff resources specifically for
abusive schemes, it used 120 FTEs in fiscal year 2002 just on abusive
domestic and foreign trusts and expected significant cascading effects on
its scheme work in the form of referrals from other units. For fiscal year


5
 Nonabusive flow-through entities are entities such as trusts and partnerships that IRS
examines as part of its broad coverage of taxpayers, even though it has no specific reason to
think they are abusive.




Page 18                           GAO-04-50 Challenges in Combating Abusive Tax Schemes
                             2004, it also requested 185 FTEs in addition to the 441 already used to
                             identify, develop, and analyze potentially fraudulent schemes in its
                             Questionable Refund Program and its Return Preparer Program. Other
                             SB/SE and IRS areas devoting FTEs to abusive schemes include the
                             Frivolous Return Program, SB/SE Communications and Liaison, and the
                             Office of Chief Counsel.



Resource Use Differed from   As of July 31, 2003, IRS had used fewer examination resources combating
Expectations, and Future     abusive schemes than it had expected. Although IRS intends to
                             significantly shift resources to address abusive schemes, how future
Use Remains to Be Seen
                             resources will actually be used remains to be seen. The future volume of
                             cases IRS will need to examine and the rate at which IRS will be able to
                             close examinations are unclear. Instead of using examination resources to
                             the extent intended to address abusive schemes, it has been able to apply
                             them to other high-priority programs, such as its Unreported Income
                             Discriminant Function effort, and if circumstances warranted, it could do
                             so again in the future.

                             As shown in table 4, through July 31, 2003, SB/SE was on track to use less
                             than half of the 1,020 fiscal year 2003 FTEs designated for abusive scheme
                             priority areas. It was on track to use 10 percent of the revenue agent FTEs
                             to be devoted to offshore credit card schemes and 30 percent of those to be
                             devoted to promoters. IRS officials stated that fiscal year 2003 was a
                             transition year and attributed the slower than expected start to overly
                             optimistic forecasts for delivering a high level of workable cases to revenue
                             agents—forecasts made without the experience needed in the promoter
                             and offshore credit card areas to gain insight into how slowly or quickly
                             inventory develops. Recent trends of more cases starting per month
                             indicate that the available workload is growing.




                             Page 19                     GAO-04-50 Challenges in Combating Abusive Tax Schemes
Table 4: Planned and Projected Revenue Agent and Tax Compliance Officer FTEs
Devoted to Abusive Scheme Priority Areas, Fiscal Year 2003


                                              Projected FTEs if the Projected FTEs as a
                                    Planned   pace at July 31, 2003 percentage of those
Priority area                          FTEs        was maintained              planned
Promoters of abusive
schemes                                150                       45                   30
Offshore credit card schemes           561                       56                   10
Other abusive schemes
worked by revenue agents               275                     352                   128
Other abusive schemes
worked by tax compliance
officers                                 34                      17                   51
Total                                 1,020                    470                    46
Source: IRS data compiled by GAO.


Other data illustrate how difficult it is for IRS to reliably estimate the
resources that may be needed to work abusive schemes due to uncertainty
about the volume of cases that it will need to examine and the rate at which
IRS will be able to close examinations. The data indicate that, at times, the
actual number of cases identified and the rate at which cases were being
closed diverged significantly from the estimates used to plan for fiscal year
2003 FTEs. For example, as shown in table 5, by July 31, 2003, SB/SE did
not yet have offshore credit card cases lined up for examination that would
approach the number the budget was intended to cover, and it had closed
only 18 percent of the cases it had anticipated closing. On the other hand,
SB/SE had more cases involving other abusive schemes in its queue for
revenue agents to handle than it had estimated it could work in fiscal year
2003, but it was closing almost twice as many cases as expected. Having
budgeted FTEs to work 9,060 complete cases involving other abusive
schemes, it had enough resources to begin and/or complete work in fiscal
year 2003 on many of the 20,810 cases it identified by July 31, 2003. It could
complete many of the unfinished cases in fiscal year 2004, and by that time,
have identified new cases to work.




Page 20                             GAO-04-50 Challenges in Combating Abusive Tax Schemes
Table 5: Comparisons of Inventory Developments with Inventory Expectations

                                                                                 Rate at which cases
                                                   Number of equivalent               expected to be
                                       Number of          cases SB/SE              closed by July 31,
                                  cases identified   estimated it could           2003 actually were
Priority area                    by July 31, 2003a    cover in FY 2003            closed by that time
Promoters                                      535                       569               Not available
Offshore credit card
schemes                                     2,208b                     9,455                         18%
Other abusive
schemes worked by
revenue agents                              20,810                     9,060                       193%
Other abusive
schemes worked by
tax compliance
officers                                     2,607                     4,570                         44%
Source: Calculated by GAO from IRS data.
a
 This calculation entailed adding the number of cases that either started in fiscal year 2003 or were
identified to be started but had not yet begun by July 31, 2003. To this total, we added cases carried
over from fiscal year 2002 into 2003, but adjusted the total to reflect that a portion of the casework had
been completed. For example, if two cases carried into 2003 were half completed, we counted them as
one case. We relied on IRS estimates of case status to make these adjustments. The resulting totals
do not represent cases that IRS could necessarily complete in fiscal year 2003 because, we were told,
many cases could take 2 or 3 years.
b
 SB/SE officials explained that over time IRS would identify additional tax returns related to the 2,208
offshore credit card cases that had been identified as of July 31, 2003. SB/SE projected that each
offshore credit card case originally identified would eventually include four tax returns, on average.


SB/SE officials told us that they accommodated shortfalls in cases or in
budgeted examination resources by shifting examination FTEs among
different types of abusive scheme examinations and to other priority
programs. According to them, the offshore credit card cases did not start as
quickly as anticipated because dealing with the summons process took
longer than expected. However, this delay allowed more SB/SE resources
to be used for other abusive schemes.

Although to date SB/SE officials have acted to accommodate unexpected
differences in the volume of cases and the time needed to work them,
uncertainties affecting future resource levels are perhaps even greater.
There is the potential that the volume of cases could grow significantly, but
it is not clear how much the caseload will grow or how quickly. For
example, in the offshore credit card scheme area, IRS has not yet assessed
how many new cases may be identified from the 214 new offshore
promoters found in its voluntary compliance initiative that closed on April



Page 21                                    GAO-04-50 Challenges in Combating Abusive Tax Schemes
15, 2003. Also, by early August 2003, IRS had received records from its
second round of credit card summonses, which covered credit card
company records on cards issued by banks in 31 offshore financial centers.
Efforts like these may potentially expand the caseload but by an unknown
amount.

To the extent the potential cases expand, IRS’s experience so far, as alluded
to earlier, has been that it is taking longer than originally expected to obtain
all of the information needed to actually identify individuals for potential
examination and to make informed choices about which cases merit
examination. IRS found, for example, that the information from credit card
summonses often was insufficient to identify individuals, and, therefore, it
had to issue summonses to merchants as well to obtain identifying
information. Therefore, IRS would be more likely to be able to handle the
examination caseload if the universe of potential examination cases
expands, even fairly significantly, but developing those cases to the point
they can actually be examined stretches out over time, than if a “workable”
caseload materializes quickly.

The fiscal year 2003 statistics in table 5 also illustrate that the rate at which
identified cases may be closed is highly uncertain. According to an SB/SE
official, SB/SE took its time estimates for working on abusive scheme cases
from its most complex abusive case examinations. SB/SE officials
explained that IRS had very little history to use in estimating the time
needed to process promoter, offshore credit card, and other abusive
scheme cases. The matrix being developed in fiscal year 2003 was designed
to collect information that will help executives assess resources needed. As
SB/SE gains experience with current cases, officials said, the planning
process would become more refined.

Across the spectrum of IRS’s responsibilities, IRS works varying amounts
of the identified workload. It has pointed to gaps between what it should be
doing and what it has the capacity to do in areas ranging from individuals
to small and large corporations. IRS will make future decisions about the
portion of abusive scheme cases that it will work as part of its overall
processes for allocating resources among its many competing priorities.




Page 22                       GAO-04-50 Challenges in Combating Abusive Tax Schemes
              We have previously raised questions about IRS’s ability to shift compliance
              resources as planned. We recently testified that many parties have
              expressed concern about declining IRS compliance—especially audit—and
              collection trends for their potential to undermine taxpayers’ motivation to
              fulfill their tax obligations.6 Concerned about these trends, IRS has sought
              more resources, including increased staffing for compliance and
              collections, since fiscal year 2001. Despite receiving requested budget
              increases, staffing levels in key occupations were lower in 2002 than in
              2000. These declines occurred for reasons such as unbudgeted expenses
              consuming budget increases and other operational workload increases.



Conclusions   Having designated abusive schemes as a priority enforcement area, IRS has
              made progress in developing an agencywide effort to address schemes. To
              ensure that these efforts are focused and to support both congressional and
              IRS assessments of progress in combating abusive schemes, IRS officials
              must follow through on their intention to develop long-term process and
              results-oriented performance goals and associated measures.

              Fiscal year 2003 experience, however, illustrates that IRS likely will need to
              continually adjust its efforts. Although IRS identified many more of some
              types of abusive schemes than it expected it could handle in fiscal year
              2003, the development of a workable inventory of offshore credit card
              scheme cases progressed much more slowly than anticipated. On balance,
              this likely led to IRS using substantially fewer resources for abusive
              scheme work in fiscal year 2003 than anticipated. As with developing long-
              term goals and measures, officials recognize that they must build a better
              analytic basis for judging the appropriate resources to assign to pursuing
              abusive schemes and intend to do so as they better identify the potential
              workload and how quickly they can close cases. Given that abusive
              schemes are a top priority for IRS and have been the focus of congressional
              attention, the potential size of the problem is a key reference point for
              policymakers in judging whether IRS has appropriate resources and an
              effective strategy over time for combating the schemes. Although
              estimating the potential size of the problem is inherently difficult and must
              rely on assumptions and officials’ judgment, documenting the basis for the



              6
               U.S. General Accounting Office, Compliance and Collection: Challenges for IRS in
              Reversing Trends and Implementing New Initiatives, GAO-03-732T (Washington, D.C.:
              May 7, 2003).




              Page 23                        GAO-04-50 Challenges in Combating Abusive Tax Schemes
                      estimates can help others judge how to interpret the numbers and use them
                      to make decisions.



Recommendation to     We recommend that the Commissioner of Internal Revenue document the
                      support underlying future IRS estimates of the size of the abusive scheme
the Commissioner of   problem when IRS prepares the estimates.
Internal Revenue

Agency Comments       In written comments, the Commissioner of Internal Revenue agreed with a
                      draft of this report. He specifically agreed with the recommendation and
                      said that IRS would establish a methodology for documenting the basis for
                      the estimates. He noted that the other information we provided would also
                      help IRS improve its abusive scheme program for fiscal year 2004 and
                      beyond. In addition, he affirmed IRS’s intention to establish measurable
                      process and results-oriented goals and said that developing these measures
                      is an operational priority for fiscal year 2004.

                      The Commissioner also provided other general comments on our draft
                      report and an update of activities since the time of our review. For instance,
                      he said that as a result of LDC improvements, expedited procedures with
                      the Department of Justice, and many other efforts, IRS recently identified
                      significant numbers of abusive scheme promoters and participants and
                      refined its methods to deal with them. In addition, he noted, a key part of
                      the ongoing, infrastructure-building efforts that we describe was forming
                      and training 12 cross-functional teams in 2003 to identify traditional or
                      alternative strategies for addressing individual schemes. Also, he stated
                      that, as of October 2003, 42 states and the District of Columbia had signed a
                      memorandum of understanding focusing on exchanging information with
                      IRS relating to abusive tax avoidance transactions. Finally, he pointed out
                      that given IRS’s inability in 2003 to consistently identify and deliver abusive
                      scheme cases to be worked in IRS field offices, IRS policy is to focus on
                      other strategic priorities when it does not have an abusive scheme case to
                      work.

                      The full text of the Commissioner’s comments is reprinted in appendix I.


                      As agreed, unless you publicly announce its contents earlier, we plan no
                      further distribution of this report until 30 days from the date of the report.



                      Page 24                      GAO-04-50 Challenges in Combating Abusive Tax Schemes
At that time, we will send copies to the Commissioner of Internal Revenue,
the Secretary of the Treasury, and other interested parties. The report will
also be available at no charge on GAO’s Web site at http://www.gao.gov.

If you or your staff have any questions about this report, please contact
Signora May on (404) 679-1920 or me on (202) 512-9110. Melissa Hinton and
Lawrence Korb were key contributors to this report.




Michael Brostek
Director, Tax Issues




Page 25                     GAO-04-50 Challenges in Combating Abusive Tax Schemes
Appendix I

Comments from the Internal Revenue Service                                   AA
                                                                              ppp
                                                                                ep
                                                                                 ned
                                                                                   n
                                                                                   x
                                                                                   id
                                                                                    e
                                                                                    x
                                                                                    Iis




              Page 26    GAO-04-50 Challenges in Combating Abusive Tax Schemes
           Appendix I
           Comments from the Internal Revenue Service




(450226)   Page 27                         GAO-04-50 Challenges in Combating Abusive Tax Schemes
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General Accounting Office      Postage & Fees Paid
Washington, D.C. 20548-0001           GAO
                                 Permit No. GI00
Official Business
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