Tax Shelters: Services Provided by External Auditors (01-FEB-05, 
GAO-05-171).							 
                                                                 
Recent legislative and regulatory changes have addressed the	 
relationship between auditor-provided tax services and auditor	 
independence. At this time, the federal regulatory community is  
exploring further changes. To contribute to the discussion	 
surrounding these changes, GAO's objectives were to determine (1)
according to Internal Revenue Service (IRS) data, how many	 
Fortune 500 companies obtained tax shelter services from their	 
auditor; (2) according to IRS data, in how many Fortune 500	 
companies did the auditor provide the services to individual	 
company officers or directors; and (3) whether selected Fortune  
500 case study companies changed how they obtain tax services	 
from their auditor in recent years. For the first two objectives,
GAO used IRS and Standard and Poor's data after finding they were
sufficiently reliable for our work. GAO counted a company,	 
officer, or director as obtaining a tax shelter service from the 
company's external auditor when an auditor that IRS identified as
promoting a tax shelter also audited the company in at least one 
year that the shelter was in effect. For the third objective,	 
independent of any IRS information, GAO selected case studies on 
the basis of geographic location and previous GAO contact. The	 
companies are illustrative in nature and not intended to be	 
representative of other companies.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-171 					        
    ACCNO:   A16596						        
  TITLE:     Tax Shelters: Services Provided by External Auditors     
     DATE:   02/01/2005 
  SUBJECT:   Corporate audits					 
	     Data collection					 
	     Federal taxes					 
	     Financial statement audits 			 
	     Noncompliance					 
	     Tax administration 				 
	     Tax shelters					 
	     Auditors						 

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GAO-05-171

United States Government Accountability Office

GAO	Report to the Ranking Minority Member, Permanent Subcommittee on

 Investigations, Committee on Homeland Security and Governmental Affairs, U.S.
                                     Senate

February 2005

TAX SHELTERS

                     Services Provided by External Auditors

                                       a

GAO-05-171

February 2005

TAX SHELTERS

Services Provided by External Auditors

[IMG]

  What GAO Found

IRS data available on tax shelter services sometimes predate legislative
and regulatory changes reflecting a heightened focus on auditor
independence. However, both during this earlier period covered by some of
the data and also following the recent changes, auditors were allowed to
provide tax services, including tax shelter services, to firms they
audited. According to IRS data, 61 Fortune 500 companies obtained tax
shelter services from their external auditor during 1998 through 2003 for
transactions generally reportable on tax returns sent to IRS. IRS
considered some reportable transactions abusive, with tax benefits subject
to disallowance under existing law, and other transactions to possibly
have some traits of abuse. Estimated multi-year potential tax revenue lost
to the federal government from the 61 companies' auditor-related
transactions was about $3.4 billion (about $1.8 billion in categories IRS
considered abusive). In 17 companies, at least one officer or director
used the company's auditor to obtain individual tax shelter services.
These numbers are imprecise because they have important limitations. These
limitations, such as some transactions in IRS's database without tax
shelter providers listed, are fully discussed in this report. Commenting
on a draft of this report, IRS said that ongoing changes and recent
legislation will enable it to address the data limitations noted.

According to their representatives, all eight case study companies adopted
or refined policies or practices in 2002 or 2003 for pre-approving tax
services or governing the tax services provided, such as who would provide
them. All eight reported using their auditor for tax services during 2000
through 2003. Two told us of obtaining tax shelter services from their
auditor, but one of them obtained the services before this period. Six of
the eight reported officers or directors obtaining individual tax services
from the auditor at some time since 2000, with four disallowing the
practice later. None reported officers or directors using the auditor for
individual tax shelter services.

Number of Fortune 500 Companies That Obtained Tax Shelter Services from
Their External Auditor and Number with Officers or Directors Who Did So,
1998 through 2003

                 United States Government Accountability Office

Contents

             Appendix I: Comments from the Internal Revenue Service
Letter                                               1 
                           Background                   4 
                        Results in Brief                6 
                     Scope and Methodology              8 
           According to Available but Limited Data, 61    
                                 Fortune 500 Companies    
           Used Tax Shelters That Had Been Promoted by 11 
                                         Their Auditor    
            According to Available but Limited Data,      
                     Officers or Directors                
              Associated with 17 Fortune 500 Companies    
                                     Used Tax Shelters    
            That Had Been Promoted by the Company's    16 
                            Auditor                       
          According to Their Representatives, All Case    
                                       Study Companies    
                 Recently Changed How They Acquire Tax    
                                   Services from Their    
                            Auditors                   17 
          Case Study Companies Said They Paid Auditors    
                                   Varying Amounts for    
             Tax Services for Company Officers and     19                  19 
                           Directors                       Agency Comments 

  Appendix

Tables	Table 1: Table 2: Table 3: Table 4:

Breakdown of the Dates Associated with Officers and
Directors Who Were Listed in S&P Data for 471
Companies 9
Types of Tax Shelters and Estimated Losses for 61 Fortune
500 Companies That Obtained Tax Shelter Services from
Their Auditor for Tax Years 1998 through 2003 11
Types of Tax Shelters and Estimated Losses for Various
Categories of Fortune 500 Companies Obtaining Tax
Shelter Services 12
Numbers of Tax Shelter Transactions and Estimated
Losses for Various Categories of Fortune 500 Companies
Whose Officers or Directors Obtained Tax Shelters 16

This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
its entirety without further permission from GAO. However, because this
work may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this material
separately.

A

United States Government Accountability Office Washington, D.C. 20548

February 1, 2005

The Honorable Carl Levin
Ranking Minority Member
Permanent Subcommittee on Investigations
Committee on Homeland Security and Governmental Affairs
United States Senate

Dear Senator Levin:

Independent public accountants play a critical role in capital and credit
markets by auditing companies' financial statements that millions of
people
rely on when investing in the nation's securities markets. Previous and
current auditor independence rules have allowed accounting firms to
provide tax services, including tax shelter services, to audit clients.
However, in May 2003, federal rules began requiring that clients' audit
committees pre-approve the services. Pre-approval requirements were
adopted pursuant to legislation that was precipitated by various corporate
accountability breakdowns.

The Internal Revenue Code has defined tax shelters in various detailed and
complicated ways for purposes of having them registered, for applying
certain penalties, or for certain tax accounting rules.1 Although IRS has
no
single, authoritative definition of abusive shelters, it has generally
characterized them as complex techniques promoted by sophisticated tax
professionals that companies and wealthy individuals use to exploit tax
loopholes and reap unintended tax benefits. Tax services include services
involving tax compliance, tax planning, and tax advice as described by the
Securities and Exchange Commission (SEC).2

126 U.S.C. sections 6111, 6662, and 461.

2Tax compliance generally involves tax return preparation, claims for
refund, and tax payment-planning services. Tax planning and tax advice
include such things as helping with tax audits and appeals and dealing
with mergers and acquisitions and rulings or technical advice from taxing
authorities. See SEC, Final Rule: Strengthening the Commission's
Requirements Regarding Auditor Independence, Release No. 33-8183
(Washington, D.C.: Jan. 28, 2003).

In November 2003, the minority staff of the Permanent Subcommittee on
Investigations reported that selling potentially abusive and illegal tax
shelters was a lucrative business, with some professional firms, including
accounting firms, mass marketing generic tax products to multiple
clients.3 Such generic tax products are potentially illegal depending on
how buyers use them and calculate their tax liabilities. In October 2003,
we testified that Internal Revenue Service (IRS) data sources, with their
various limitations, suggested that abusive tax shelters totaled tens of
billions of dollars of potential tax losses over about a decade.4 More
recently, the federal regulatory community has proposed more changes
relating to the effect of auditor-provided tax services on auditor
independence. In that context, we are providing information on
auditor-provided tax services, including tax shelter services.

As discussed with your office, our objectives were to obtain information
on both tax shelter services and other tax services provided by auditors
of Fortune 500 companies. Specifically, our objectives were to determine
(1) according to IRS data, how many Fortune 500 companies obtained tax
shelter services from their auditor; (2) according to IRS data, in how
many Fortune 500 companies did the auditor provide the services to
individual company officers or directors; (3) whether selected Fortune 500
case study companies changed how they obtain tax services from their
auditor in recent years; and (4) how many of our case study companies
provided company funds to their auditor for tax shelter or other tax
services for company officers or directors, and what the minimum and
maximum amounts of the funds provided were.

To accomplish our first two objectives, we matched data disclosed to or
discovered by IRS on tax shelter acquisitions and promoters of the tax
shelters to information we acquired from Standard and Poor's (S&P) on the
auditors, top officers, and directors of the April 2003 Fortune 500.5 We

3Minority staff of the Permanent Subcommittee on Investigations, U.S.
Senate Committee on Governmental Affairs, U.S. Tax Shelter Industry: The
Role of Accountants, Lawyers, and Financial Professionals (Washington,
D.C.: November 2003).

4GAO, Internal Revenue Service: Challenges Remain in Combating Abusive Tax
Shelters, GAO-04-104T (Washington, D.C.: Oct. 21, 2003).

5The Fortune 500, published annually by Fortune magazine, consists of the
500 largest U.S. corporations, in terms of revenue, that publish financial
data and must report part or all of their figures to a government agency.
The April 2003 list that we used ranked companies according to their 2002
revenues.

considered a company, officer, or director as obtaining tax shelter
services from the company's auditor when, for at least one of the tax
years for which the company, officer, or director received a tax shelter
benefit, the company's auditor was identified as a promoter of the tax
shelter by IRS. We used the company's fiscal year 1998 through 2003
auditors for performing our analysis and analyzed information from other
years to provide context.

Although we found the data elements we used from the IRS and S&P
information were sufficiently reliable for the purposes of our work, as
will be described later, the IRS data had important limitations and should
be used with caution. Despite these limitations, the information in this
report provides a general indication of the extent to which Fortune 500
companies and their officers or directors used their external auditor for
tax shelter services. Our results are imprecise in reflecting the universe
of companies, officers, and directors that might have obtained tax shelter
services from the companies' auditors. For example, IRS's data may not
include all tax shelters because some taxpayers may not have disclosed all
abusive or other reportable transactions to IRS, and IRS likely has not
identified all such transactions on its own. On the other hand, the data
also might include some tax shelters that could later be determined
nonabusive and did include some items that needed to be reported to IRS
but unexpectedly turned out to be nonabusive. Although not all
transactions turned out to be abusive, we have included in our analysis
those transactions that IRS or taxpayers believed needed to be reported to
the federal government.

To accomplish our last two objectives, independent of any IRS information,
we studied eight Fortune 500 companies that were not intended to be
representative of other companies, and we collected information from their
management and audit committee chairs on tax services, including tax
shelter services, the eight companies obtained. We chose companies that
were geographically diverse and whose audit committee chair had not been
recently contacted for other GAO studies.

We did our work between December 2003 and January 2005 in accordance with
generally accepted government auditing standards. A later section of this
report contains a complete discussion of our scope and methodology.

Background	Both SEC and IRS have had an interest in the tax services,
particularly tax shelter services, that accounting firms provide
taxpayers. In terms of SEC, according to the Sarbanes-Oxley Act of 2002,6
before an SEC registrant company's auditor can provide non-audit services
such as tax services to the company, the company's audit committee must
approve them. Effective May 6, 2003, SEC adopted rules required by the act
to strengthen conflict of interest standards and clarify the relationship
between the independent auditor and the audit committee.

In adopting these rules, SEC said it was enhancing the independence of
accountants that audited financial statements and prepared related reports
to be filed with SEC. It also said that accounting firms could provide tax
services to their audit clients, subject to each client's audit committee
preapproval, without impairing their independence. However, accountants
would impair their independence if they represented audit clients before a
tax or district court or a federal court of claims. Further, according to
the rules, audit committees should carefully scrutinize an accountant's
involvement in a transaction if the accountant initially recommended the
transaction, the transaction's sole business purpose might be tax
avoidance, and its tax treatment might not be supported in the Internal
Revenue Code and related regulations.

The Sarbanes-Oxley Act established the Public Company Accounting Oversight
Board (PCAOB) and authorized it to establish standards and rules for
auditor independence. In exercising its responsibilities under the act,
PCAOB determined it was appropriate to consider the impact on auditor
independence of providing tax services to audit clients. In July 2004, it
convened a roundtable discussion on the effect of tax services provided by
auditors on auditor independence. Participants at the roundtable,
including representatives of accounting firms, public companies,
investors, and regulators, discussed many different topics, with
suggestions including more PCAOB guidance to audit committees and a rule
barring auditors from providing at least some tax services to audit
clients.

6Pub. L. No. 107-204, July 30, 2002.

On December 14, 2004, PCAOB proposed new ethics and independence rules,
with comments due by February 14, 2005, and an effective date of no
earlier than October 20, 2005. The proposed rules would treat an
accounting firm registered with PCAOB as not independent in certain
instances for purposes of doing a financial statement audit and for other
purposes. For example, the firm would be considered not independent if it
provided services related to planning or giving an opinion on the tax
treatment of a listed (described later) or confidential transaction under
Department of the Treasury regulations. Similarly, the firm would be
considered not independent if it provided these services for a transaction
that was based on an aggressive interpretation of the applicable tax laws
and regulations. Such a transaction is one that satisfies three criteria:
it was initially recommended by a tax advisor; it has tax avoidance as a
significant purpose; and it "is not at least more likely than not to be
allowed under; applicable tax laws."7 The proposal would also treat the
firm as not independent if the firm provided tax services to officers who
oversee an audit client's financial reporting. It would not prohibit the
audit firm from providing the audit client with routine tax return
preparation and tax compliance, general tax planning and advice,
international assignment tax services, and employee personal tax services.
In addition, the proposal would expand on current SEC pre-approval
requirements to require an auditor seeking audit committee pre-approval of
tax services to give the committee certain information, discuss with the
committee the services' potential effects on the firm's independence, and
document the discussion's substance.

Treasury regulations address IRS's oversight of tax shelters. Under the
regulations,8 there are six categories of transactions for which investors
must report, or disclose, the transactions into which they have entered,
and promoters must maintain lists of investors who have entered into the
transactions.

7Public Company Accounting Oversight Board, PCAOB Release No. 2004-015
(Washington, D.C.: Dec. 14, 2004.)

8Treas. Reg. Sec. 301.6112-1 and Treas. Reg. Sec. 1.6011-4.

At IRS, the Office of Tax Shelter Analysis (OTSA) maintains a database
containing information on tax shelter investors and promoters, including
accounting firms.9 Created in February 2000 to centralize and coordinate
IRS's response to abusive tax shelter activity nationwide, OTSA includes
in its database the amount of potential federal tax loss estimated by the
taxpayer or IRS to result from both listed and nonlisted transactions.
These losses, which also represent benefits to the taxpayer, may or may
not be disallowed by IRS upon further review of each transaction. IRS
considers listed transactions, which must be reported on tax returns sent
to IRS, to be abusive. The Joint Committee on Taxation has described
listed transactions as having a tax avoidance purpose, with the tax
benefits subject to disallowance under existing law.10 For a transaction
to be listed, IRS must issue a notice, regulation, or other form of
published guidance informing taxpayers of the details of the transaction.
In October 2004, IRS had 30 types of listed transactions, a number that
had grown more quickly in recent years than earlier. Nonlisted
transactions generally are transactions reportable to IRS that may have
some characteristics of abusive shelters but are not, and may never be,
listed. At times, IRS questions whether some nonlisted transactions should
be moved into the category of listed transactions.

Results in Brief	According to available IRS data, for the period from 1998
through 2003, 61 Fortune 500 companies obtained tax shelter services from
an accounting firm that was the company's external auditor for at least
one year that the company received federal tax benefits from the shelter.
These tax shelter transactions were generally reportable on tax returns
sent to IRS. The estimated potential tax revenue loss to the federal
government over many years for these auditor-promoted transactions used by
the 61 companies was about $3.4 billion, with about $1.8 billion in
categories IRS considered to be abusive. More companies-114--obtained tax
shelter services from any accounting firm and received tax shelter
benefits for any year in IRS's database, including the 61 companies that
obtained auditor-related services. By comparison, a total of 207 Fortune
500 companies obtained

9According to an IRS official and IRS Form 8886, the database includes as
a promoter a person, including an entity such as an accounting firm, that
received a fee with regard to a transaction if that person promoted,
solicited, or recommended a taxpayer's participation in the transaction,
or provided tax advice related to the transaction.

10Joint Committee on Taxation, Background and Present Law Relating to Tax
Shelters, JCX-19-02 (Washington, D.C.: Mar. 19, 2002).

tax shelter services from any type of firm that provided these services-
including the 114 companies that obtained services from accounting firms.
The estimated potential tax revenue loss to the federal government over
many years for these 207 companies was about $56 billion, about 44 percent
of it related to tax years 1998 through 2003. The revenue loss estimates
are sometimes from the individual companies and sometimes from IRS. These
numbers are imprecise because they have important limitations. These
limitations, such as some transactions in IRS's database without tax
shelter providers listed, are fully discussed in this report.

In 17 of the Fortune 500 companies for which we had data on company
officers and directors, at least one officer or director used the
company's auditor to obtain individual tax shelter services for at least 1
year from 1998 through 2003. By comparison, officers and directors in more
companies- 33--used any accounting firm for tax shelter services. In a
total of 57 companies, at least one officer or director obtained tax
shelter services from any type of firm, including accounting firms and
others, providing such services.

Representatives of all eight companies we studied in more depth said they
adopted or refined policies or practices in 2002 or 2003 for pre-approving
tax services or governing the tax services that could be provided, such as
who would provide them. Examples of changes made include requiring that
all engagements with the outside auditor be subject to approval by the
company's audit committee and directing more work to other tax service
providers. All eight companies reported using their auditor for some tax
services during the period from 2000 through 2003. The services ranged
from preparing or reviewing company tax returns to consulting on foreign
tax transactions, and the companies told us that the specific services
changed over time. Two of the eight companies we studied told us of
obtaining tax shelter services from their auditor, but one of them
obtained the services before 2000. The two companies were among three
companies that said they did not have a current policy prohibiting
obtaining tax shelter services. None of our eight case study participants
reported officers or directors obtaining tax shelter services from the
auditors, but six of the companies reported that at some time since 2000
their officers or directors obtained other tax services from the auditors.
In four of these cases, officials said obtaining such services was later
disallowed by the company.

Officials from four of the eight companies we studied said their companies
paid auditors varying amounts for tax services for company officers and
directors for 2001, and the other four paid nothing. Two companies

indicated one paid about $8,000 and the other about $13,000 for these
services. Two other companies did not provide specific amounts but
reported paying more than $0 but less than or equal to $1 million, a
category we used in collecting these data.

We are not making any recommendations in this report.

In written comments on a draft of this report, the Commissioner of
Internal Revenue said it was comprehensive and provided an accurate
picture of the factors affecting IRS's ability to have an accurate tax
shelter database. He added that changes IRS was making and recent
legislation will enable IRS to address the data limitations we note in our
report.

  Scope and Methodology

To address our first two objectives-relating to Fortune 500 companies,
officers, and directors obtaining tax shelter services from their company
auditors--we matched data from two sources-S&P and IRS. We acquired
specific S&P data elements for the 497 companies on the April 2003 Fortune
500 list that, according to S&P, either were publicly owned or had to file
with SEC for another reason, such as having publicly-traded debt. The data
elements included the company's employer identification number, the names
of company officers and directors, and the name of the company's auditor
for each year from 1998 through 2003. The number of Fortune 500 companies
for which we actually received S&P data varied; for instance, we received
names of directors and officers for 471 companies and employer
identification numbers for 492.

As shown in table 1, the officers for 441 of the 471 companies were those
listed in the company's proxy statement section on most highly compensated
officers, as filed with SEC for either 2000 or 2002. We used the years
2000 and 2002 because those were years when the federal government was
significantly enhancing its presence to counter tax shelter activity that
might have been going on for years. Because S&P did not have similar top
officer information for the other companies in the Fortune 500, or 2000 or
2002 director information for any of them, it gave us the names reflecting
current officers and directors as of March 2004-the date we obtained the
data. Obviously, some of the March 2004 officers for 30 companies and the
March 2004 directors for all 471 might have been different from those
working in 2000 or 2002, which was closer to the time when most of the tax
benefits related to the shelters were taken. Consequently, our analysis of
the March 2004 information omits any officers and directors who left the
relevant companies after 2002.

Table 1: Breakdown of the Dates Associated with Officers and Directors Who
Were Listed in S&P Data for 471 Companies

Number of companies Dates for officers Dates for directors

441 2000 or 2002 March 2004

March 2004 March 2004

Source: Information GAO received from S&P.

We matched the S&P data to tax shelter information in IRS's OTSA database
as of May 28, 2004. IRS's database included information disclosed to or
discovered by IRS on companies, individuals, and other taxpayers who used
tax shelters. It also included information on as many as three entities,
including accounting firms, which IRS said promoted the shelter to the
investor. We considered both listed and nonlisted transactions in the
database because from an auditor independence standpoint, in both cases
the promoters were involved with transactions that IRS or taxpayers
believed needed to be reported to the federal government.

To determine to what extent the 497 companies obtained tax shelter
services, we matched the employer identification numbers in the S&P and
IRS databases. When we found a match, we checked the promoter information
in the IRS database against the audit firm information in the S&P database
to see if the same accounting firm was listed as a promoter for a
particular transaction and as the company's auditor for one or more years
that the shelter benefited the company. Although we do not know for sure
that a company obtained tax shelter and auditing services from an
accounting firm at exactly the same time, we considered it a match when at
least one of the tax years for which the company received a tax benefit
matched a fiscal year from 1998 through 2003 for which the accounting firm
was the company's auditor. We did this because IRS did not have
information on exactly when taxpayers obtained tax shelter services, and
1998 was the year before the Department of the Treasury reported that the
proliferation of corporate tax shelters was unacceptable.11 We analyzed
information from other years to provide context.

We also matched the names of company officers and directors in the S&P
data to the names of the tax shelter investors in the IRS database.

11Department of the Treasury, The Problem of Corporate Tax Shelters
(Washington, D.C.: July 1999).

Whenever we found a match, we tried to verify if the same person was
actually involved, as opposed to two people with the same first and last
names. If the person appeared to be the same (for example, had the same
middle initial), we matched the promoter name for that individual and,
similar to what was just described, the tax benefit dates in the IRS
database to the auditing firm of the individual's company for 1998 through
2003 in the S&P data. Our matching methodology did not allow us to detect
instances in which a spouse or other relative of the officer or director
was the tax shelter investor or instances in which the investing entity
was a partnership or other unit formed by the officer or director.

As part of our work, we tested the reliability of IRS's database and the
data we received from S&P. For the IRS database, we reviewed related
documentation, interviewed knowledgeable officials, and did electronic
testing. For the information received from S&P, we reviewed S&P
information on its controls over the data and verified sample data to
publicly available documents obtained from SEC's Web site or elsewhere.
For both types of data, we found that the required data elements were
sufficiently reliable for the purposes of our work. However, as we will
describe later, the IRS database had important limitations and therefore
our results are imprecise in reflecting the universe of companies,
officers, and directors that might have obtained tax shelter services from
the companies' auditors.

To deal with our last two objectives--those on case study companies
obtaining tax shelter and other tax services from their auditor and
funding these services for officers and directors--we selected publicly
traded companies among the Fortune 500 to study in depth. Independent of
any IRS information, we reviewed the April 2003 Fortune 500 list and chose
companies that were headquartered in three geographically diverse parts of
the country and whose audit committee chair worked or lived in one of
those areas. We excluded companies whose audit committee chairs had been
contacted in other recent GAO studies.12 Of the 23 companies that met our
criteria, 8 agreed to provide information in response to a structured
interview guide we used. For 5 of these 8 companies, we interviewed the
audit committee chair. For the other 3, we relied only on written answers

12GAO, Public Accounting Firms: Mandated Study on Consolidation and
Competition, GAO-03-864 (Washington, D.C.: July 30, 2003) and GAO, Public
Accounting Firms: Required Study on the Potential Effects of Mandatory
Audit Firm Rotation, GAO-04-216 (Washington, D.C.: Nov. 21, 2003).

we received from the companies. Because we studied so few companies and
because of the method of selection, we cannot say that the responses we
received represent any larger group of companies. Further, the companies
that we did study might have agreed to participate because they had
special reasons for wanting to share their tax services experiences with
us. Although they were not representative of change overall, we believe
that the 8 companies illustrate some of the changes that have occurred in
recent years related to auditors providing tax services.

We did our work between December 2003 and January 2005 in accordance with
generally accepted government auditing standards.

  According to Available but Limited Data, 61 Fortune 500 Companies Used Tax
  SheltersThat Had Been Promoted by Their Auditor

As shown in table 2, 61 Fortune 500 companies used a tax shelter that was
promoted by an accounting firm that was their external auditor for one or
more years from 1998 through 2003 in which the company received benefits
from the tax shelter. The 61 companies had 82 transactions worth about
$3.4 billion in estimated potential tax losses over many years for
transactions that were generally reportable on tax returns sent to IRS.
They are out of 492 Fortune 500 companies for which S&P supplied employer
identification numbers and for which we searched for a match in the May
28, 2004 version of IRS's tax shelter database.

Table 2: Types of Tax Shelters and Estimated Losses for 61 Fortune 500
Companies That Obtained Tax Shelter Services from Their Auditor for Tax
Years 1998 through 2003a

Number of tax shelter Taxpayer or IRS estimates transactions by IRS of
potential tax loss category (billions)b

Listed Nonlisted Total Listed Nonlisted Total

Tax shelter transactions
involving the company's
auditor for 61 Fortune 500
companies 42 40 82 $1.8 $1.6 $3.4

Source: GAO analysis of IRS's May 28, 2004 OTSA database and S&P data.

aSee text in the next subsection for a discussion of data limitations that
may result in a misstatement of the number of companies obtaining tax
shelter services from their auditors.

bThe estimated potential tax loss covers a multiyear period and has
important limitations, such as not considering reductions in IRS estimates
that may result from examination, appeal, litigation, or other sources,
and not including potential tax loss estimates for many transactions.

Table 3 puts this information into various contexts. For instance,
including the 61 companies just described, 67 companies with about $4.1
billion in tax shelter benefits obtained tax shelter services from a firm
that was their auditor sometime, but not necessarily in the same year the
company received some or all the related tax shelter benefits. We include
the 6 additional companies because some analysts have questioned the
propriety of accounting firms promoting tax shelters even to companies
they are not currently auditing. For example, recent press reports
described a company that employed an accounting firm as its auditor
sometime after the year for which the company claimed a tax shelter
benefit from the shelter provided by the accounting firm. According to the
reports, the auditor began auditing financial statement items resulting
from the tax shelter that it had previously provided, a task the auditor
said was within SEC rules.

Table 3: Types of Tax Shelters and Estimated Losses for Various Categories
of Fortune 500 Companies Obtaining Tax Shelter Servicesa

Number of tax shelter Taxpayer or IRS estimates transactions by IRS of
potential tax loss category (billions)b

Listed Nonlisted Total Listed Nonlisted Total

Tax shelter transactions
involving a firm that was the
company's auditor at any
time-67 Fortune 500
companies 55 45 100 $2.4 $1.7 $4.1

Tax shelter transactions with
any accounting firm
involvement-114 Fortune
500 companies 97 99 196 4.0 4.6 8.6

Tax shelter transactions with
any accounting firm
involvement-4,383
taxpayers, including
individuals 4,311 761 5,072 12.3 11.4 23.6c

             Tax shelter transactions of                                
               207 Fortune 500 companies                                
                         in the database   396     636 1,032  16.1 39.5  55.6 
         Tax shelter transactions of all                                
             10,371 taxpayers, including                                
            individuals, in the database 12,261  2,779 15,040 43.0 85.9 128.9 

Source: GAO analysis of IRS's May 28, 2004 OTSA database and S&P data.

aSee text in the next subsection for a discussion of data limitations that
may result in a misstatement of the number of companies obtaining tax
shelter services.

bThe estimated potential tax loss covers a multiyear period and has
important limitations, such as not considering reductions in IRS estimates
that may result from examination, appeal, litigation, or other sources,
and not including potential tax loss estimates for many transactions.

cTotal does not equal sum of components due to rounding.

For further context, table 3 shows that including the 67 companies, 114
Fortune 500 companies and almost 4,400 total taxpayers obtained tax
shelter services from accounting firms, including firms they had not ever
used as auditors but might one day. The estimated potential tax losses
involved were about $9 billion for the 114 companies for any year in IRS's
database and about $24 billion for all taxpayers.13 Although we did not
have enough information to know whether taxpayers obtained fewer tax
shelter services from accounting firms as time went on, several accounting
firms testified in November 2003 before the Permanent Subcommittee on
Investigations of the Senate Committee on Governmental Affairs that they
had scaled back their tax shelter activities in general.

Including the 114 companies, 207 Fortune 500 companies, regardless of who
their promoters were, used tax shelters accounting for about $56 billion
in estimated potential tax losses, about 44 percent of it related to tax
years 1998 through 2003. To break out the $56 billion further, of the 492
Fortune 500 companies for whom S&P supplied employer identification
numbers, 139 appeared in IRS's database to have engaged in listed
transactions with estimated potential tax losses of about $16 billion. The
number of companies engaged in nonlisted transactions estimated to be
potentially worth about $40 billion was 129, and because some companies
were involved in both kinds of transactions, the number engaged in either
listed or nonlisted transactions was 207.

The 207 Fortune 500 companies' transactions are part of IRS's total tax
shelter database. As of May 28, 2004, for all taxpayers, the database
contained listed and nonlisted transactions with estimated potential tax
losses of about $129 billion, about half of it related to tax years 1998
through 2003. Most of the dollar amounts related to nonlisted, as opposed
to listed, transactions, and some of the amounts shown as listed might
represent transactions that taxpayers entered into before IRS had
designated them as listed. About a third of the approximately 15,000

13The tax losses estimated by taxpayers and IRS and contained in IRS's
OTSA database cover a wide range of years from at least as far back as tax
year 1989 and extending even to future tax years since, for instance,
improperly claimed deductions may be used in some cases to reduce future
taxes.

transactions in the database had an accounting firm listed as a promoter,
and these transactions accounted for about 18 percent of the $129 billion
estimated potential tax loss.

IRS Database Limitations	We and IRS know the numbers in this section are
not precise. Some of the imprecision could make the count of transactions
and associated estimated potential losses too high, and some could make
them too low. Accordingly, the numbers should be used with caution and
should be understood and used as general estimates of the degree to which
companies might have obtained tax shelter services from external auditors
and of the possible dollar magnitude of the associated tax benefits, and
thus possible decreased federal revenues.

The numbers could be overestimates for the following reasons:

o 	The number of abusive transactions and their dollar amounts might have
been or might still be reduced upon further examination, appeal,
litigation, or other action.

o 	The database included some reported transactions that turned out to be
nonabusive. Additional transactions might later be found to be nonabusive.

o 	According to an IRS official, the database included some tax shelter
transactions more than once-at the level of a flow-through entity, such as
a partnership, and again at the level of the taxpayers, for example, the
individual partners-with the relevant dollar amounts thus appearing twice.
This limitation would not apply to information dealing only with Fortune
500 companies' use of tax shelters.

The numbers could be underestimates for the following reasons:

o 	The IRS database did not include promoters for about a quarter of the
transactions of the 207 Fortune 500 companies that used tax shelters. In
these cases, the tax shelter might have been obtained using a promoter
that the taxpayer did not identify to IRS, or, according to an IRS
official, a very few taxpayers not working for firms designing tax
shelters might have developed their own tax shelter. In total, the
database did not include promoters for 2,095, or about 14 percent, of its
transactions as of May 28, 2004.

o 	The database did not reflect estimated potential tax losses for about a
third of the transactions of the Fortune 500 companies using an accounting
firm to obtain tax shelters, or for about a quarter of the transactions of
the total number of Fortune 500 companies obtaining tax shelters.
According to an IRS official, this was because taxpayers did not include
estimated losses on documents submitted to IRS. The official added that a
possible reason for taxpayers not disclosing such information was that
nondisclosure penalties did not yet exist.14 The database did not reflect
estimated potential tax losses for about twothirds of the 15,040 total
transactions it contained. These potential losses could range from small
to large amounts; however, their distribution is unknown.

o 	In addition, as of May 28, 2004, IRS had not yet entered into the
database all of the tax shelter information that it possessed even though
the information included data pertaining to transactions done years ago.

o 	The database only included information on abusive or possibly abusive
transactions that had been disclosed to or discovered by IRS, and as
alluded to earlier, the number of listed transactions had continually
grown from even before OTSA was established.

Adding to the uncertainty, the tax loss estimates in the database vary
from being IRS officials' recommended taxes, based on examining some
transactions, to taxpayer judgments regarding potential losses in cases
where examinations had not been done. According to an IRS official,
taxpayer-provided information may represent estimates or incomplete
information.

Despite these data limitations, the numbers we present in this report
provide a general indication of the extent to which Fortune 500 companies
did use their external auditor for tax shelter services. In addition, they
include larger numbers showing that many Fortune 500 and other taxpayers
obtained tax shelter services using their own and other accounting firms,
and many obtained tax shelters without using accounting firms at all.

14The American Jobs Creation Act of 2004, Pub. L. No. 108-357, Oct. 22,
2004, created such penalties.

  According to Available but Limited Data, Officers or Directors Associated with
  17 Fortune 500 Companies Used Tax SheltersThat Had Been Promoted by the
  Company's Auditor

As shown in table 4, one or more officers or directors of 17 Fortune 500
companies used tax shelters that were promoted by an accounting firm that
was the Fortune 500 company's external auditor during at least one of the
years that the officer or director benefited from the tax shelter. The
years in question were 1998 through 2003, and the potential tax loss from
these transactions was about $100 million. The officers or directors are
from 471 Fortune 500 companies for which we had data on officers or
directors from S&P that we matched against data in the May 28, 2004
version of IRS's tax shelter database.

Table 4: Numbers of Tax Shelter Transactions and Estimated Losses for
Various Categories of Fortune 500 Companies Whose Officers or Directors
Obtained Tax Sheltersa Taxpayer or IRS

Number of estimates of

tax shelter potential tax transactions loss (billions)b

                  Tax shelter transactions of officers and          
              directors involving the company's auditor-17          
                                     Fortune 500 companies    33         $0.1 
                  Tax shelter transactions of officers and          
                directors involving any accounting firm-33          
                                     Fortune 500 companies    53    
              All tax shelter transactions of officers and          
                        directors-57 Fortune 500 companies    87    

Source: GAO analysis of IRS's May 28, 2004 OTSA database and S&P data.

aSee the accompanying text for a discussion of data limitations that may
result in a misstatement of the number of companies whose officers or
directors obtained tax shelter services.

bThe estimated potential tax loss covers a multiyear period and has
important limitations, such as not considering reductions in IRS estimates
that may result from examination, appeal, litigation, or other sources,
and not including potential tax loss estimates for many transactions.

To place the officers and directors of the 17 companies into context, in
33 companies, a transaction of at least one officer or director had an
accounting firm listed as a promoter,15 and in 57 of them, at least one
officer or director obtained a tax shelter regardless of whom he or she
used as a

15The fact that the IRS database shows about 4,400 taxpayers obtaining tax
shelter services from an accounting firm shows that many of the taxpayers
using accounting firms for tax shelter work were neither Fortune 500
companies nor their officers or directors.

promoter. The number of officers and directors involved in even the 57
companies translated to less than one percent of the officers and
directors of Fortune 500 companies that we matched against IRS's database.

These numbers relating to officers and directors of Fortune 500 companies
are subject to the limitations described previously for the numbers
related to the companies themselves. For example, IRS's database did not
list promoters or estimated potential tax losses for every transaction. In
addition, according to an IRS official, disclosures from individuals,
partnerships, and S corporations, which were first due to IRS for filing
year 2003, arrived in great numbers beginning in April 2004, and many were
not yet entered into the IRS database as of May 28, 2004.

  According to Their Representatives, All Case Study Companies Recently Changed
  How They Acquire Tax Services from Their Auditors

According to their representatives, all eight of our case study companies
adopted or refined policies or practices in 2002 or 2003 requiring their
audit committees to pre-approve tax services to be obtained or governing
the tax services provided. At least some of these changes were in response
to the Sarbanes-Oxley Act. Examples of changes made include requiring that
all engagements with the external auditor be subject to approval and
directing more work to other providers. As stated earlier, these companies
are not representative of other companies because of their small number,
the way we selected them, and their unknown motivation for participating
with us. However, they do illustrate that the provision of tax services
has changed in recent years for at least some companies.

According to company representatives, all eight case study companies
obtained tax services from their auditors during the period from 2000
through 2003.16 Services provided ranged from company to company,
sometimes involving, for instance, tax return preparation, tax return
review, advice on foreign tax transactions, or consultations on

16In 2003, a GAO report included information from which we calculated that
82 percent, or 130 of 159, respondents to an unprojected GAO survey of
Fortune 1000 companies received tax-related services, such as tax
preparation, from their auditor. See GAO, Accounting Firm Consolidation:
Selected Large Public Company Views on Audit Fees, Quality, Independence,
and Choice, GAO-03-1158 (Washington, D.C.: Sept. 30, 2003). Similarly, in
2004, Glass, Lewis & Co. included information from which we calculated
that about 95 percent of the approximately 460 Fortune 500 companies it
reviewed paid tax fees to their auditors in 2003. See Glass, Lewis & Co.,
LLC, Auditor Fees: The Price of an Independent, Quality Audit (2004).

negotiations. Only two of the companies told us of obtaining tax shelter
services, and one of them obtained the services before 2000.

Company representatives told us about how specific services the company
acquired changed over time. In fiscal year 2004, one company's audit
committee rejected auditor involvement in a particular tax strategy out of
concern that the auditor could potentially be in the position of auditing
its own work. Another company told us of discontinuing an arrangement for
obtaining certain tax services from its auditor because of the
arrangement's undesirable appearance. A third company told us of
transferring some tax services from its auditor to other providers in 2003
and 2004 because the audit committee began requiring a compelling reason
to use its auditor for the services. In spite of these changes, in stating
general impressions, six case study companies said that having their audit
firm provide tax services brought efficiency and effectiveness gains due
to the firm's understanding of the company and its business.

The two case study companies that obtained tax shelter services in the
past were among the three companies of the eight that said they did not
have a current policy prohibiting obtaining tax shelter services. However,
one of the two companies said that it did not plan to obtain tax shelters
in the future. According to both companies, IRS challenged the tax shelter
claimed, and the issue had not yet been resolved.

    Six of Eight Case Study Companies Said They Allowed Officers and Directors
    to Obtain Tax Services from the External Auditor, but Four Said They Then
    Stopped

Although six of our case study companies reported that officers or
directors at some time since 2000 used the auditor for some tax services,
such as tax return preparation, officials told us that four of the
companies in 2002 or 2003 adopted policies prohibiting officers from using
the auditor for the services in the future. One company cited auditor
independence reasons for removing as of 2003 its requirement that a
particular executive use the company's auditor. In contrast to the
situation with tax services in general, none of the companies reported
officers or directors obtaining tax shelter services from the company
auditor.

Three companies we contacted said they did not have a policy prohibiting
officers from obtaining tax services from the company auditor. However,
even among those, one company knew of no officers who had actually used
the auditor from 2000 onward for tax services. Another company allowed
using the auditor but annually surveyed its senior officers about
perceived or actual conflicts of interest. The third said its executives
could use the auditor but had done so only in limited instances.

  Case Study Companies Said They Paid Auditors Varying Amounts for Tax Services
  for Company Officers and Directors

For the year we asked about in which officers or directors were still
using the company auditor for tax services-2001-two case study companies
that paid for these services indicated one paid the auditor about $8,000
and the other about $13,000. Although two other companies reported paying
for these services, they did not provide us with specific amounts. Both
fell into the lowest non-zero choice of range we provided-greater than $0
but less than or equal to $1 million.17 The other four of the eight
companies we studied reported paying their auditors nothing in 2001 for
tax services for officers or directors.18

In general and not restricted to 2001, five case study companies reported
setting aside funds for, or annually paying for, tax services that
officers or directors obtain from their auditors or others. In those
cases, company figures varied from a range of $30,000 to $50,000 in one
case to $150,000 in another.

Agency Comments	In written comments on a draft of this report, the
Commissioner of Internal Revenue said it was comprehensive and provided an
accurate picture of the factors affecting IRS's ability to have an
accurate tax shelter database. He particularly pointed to indications in
the draft report that not all the information in the database might relate
to abusive tax avoidance transactions.

The Commissioner also said that IRS changes and recent legislation will
enable IRS to address the database limitations we note, several of which
IRS had already identified and was working to overcome. He added that IRS
was creating a new database and exploring considering whether various IRS
forms should be revised to improve the quality of information IRS
receives. In addition, he noted that IRS supported the December 2004 PCAOB
action to revise auditor ethics and independence rules.

17We used this broad a range in light of press reports showing fees of $1
million and more.

182001 was the last year for which publicly held companies did not have to
report to SEC the amounts of tax fees paid to the company auditor for all
tax services, including any for officers or directors. For fiscal years
ending after December 15, 2003, companies for the first time had to
publicly disclose these tax fees, and they had to do it for the last 2
fiscal years. According to these reported amounts, for five of the eight
case study companies, 2003 tax fees were lower than 2002 tax fees. Reasons
given to us for the decline in individual company tax fees included a
large number of tax-related transactions in 2002 and the need to spend
more money in 2002 to deal with an IRS audit and to use auditor software.

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

As discussed with your staff, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from
the date of the report. At that time, we will send copies to the Chairmen
and Ranking Minority Members of the Senate Committee on Finance and the
House Committee on Ways and Means, the Commissioner of Internal Revenue,
and other interested parties. The report will also be available at no
charge on GAO's Web site at http://www.gao.gov.

If you or your staff have any questions about this report, please contact
me at (202) 512-9110 or at [email protected] or Signora May at (404)
679-1920 or at [email protected]. Jeffrey Arkin, Lawrence Korb, MacDonald
Phillips, Tina Smith, James Ungvarsky, and Walter Vance were key
contributors to this report.

Sincerely yours,

Michael Brostek Director, Tax Issues

                                   Appendix I

                   Comments from the Internal Revenue Service

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