Tax Administration: Additional Time Needed to Complete Offshore  
Tax Evasion Examinations (30-MAR-07, GAO-07-237).		 
                                                                 
Much offshore financial activity is not illegal, but numerous	 
illegal offshore schemes have been devised to hide or disguise	 
the true ownership of income streams and assets. IRS studies show
lengthy development times for some offshore cases, which suggests
that time or the lack thereof could be an impediment to 	 
effectively addressing offshore schemes. GAO was asked to (1)	 
compare offshore and nonoffshore examination cases and determine 
whether the 3-year statute of limitations reduces offshore	 
assessments, (2) compare enforcement problems posed by offshore  
cases to those where Congress has previously granted an exception
to the statute, and (3) identify possible advantages and	 
disadvantages of an exception to the statute for offshore cases. 
To address these objectives, GAO analyzed IRS data, reviewed	 
examination files and other documents, and interviewed IRS	 
officials and others in the tax practitioner and policy 	 
communities.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-237 					        
    ACCNO:   A67574						        
  TITLE:     Tax Administration: Additional Time Needed to Complete   
Offshore Tax Evasion Examinations				 
     DATE:   03/30/2007 
  SUBJECT:   Assets						 
	     Criminal activities				 
	     Fraud						 
	     Internal controls					 
	     Law enforcement					 
	     Tax evasion					 
	     Tax shelters					 
	     Tax violations					 

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GAO-07-237

   

     * [1]Results in Brief
     * [2]Background
     * [3]Offshore Examinations Take Longer Than Other Examinations, s

          * [4]Offshore Cases Take Longer for IRS to Develop and Examine
          * [5]Completed Offshore Examinations Yield Larger Recommended Ass
          * [6]To Prevent Violating the Statute of Limitations, IRS Does No

     * [7]Some Offshore Examinations Present Enforcement Problems Simi

          * [8]Offshore Enforcement Problems Are Similar to Those Justifyin

               * [9]Historical Changes and Exceptions
               * [10]Recent Federal Exception to the Statute
               * [11]California Statute Change
               * [12]Legislative Reports Discuss Reasons for Change

          * [13]Precedent Exists for Changing the Statute for Offshore Exami

     * [14]Changing the Statute Would Necessitate Weighing Advantages a

          * [15]Advantages and Disadvantages of Changing the Statute

     * [16]Conclusions
     * [17]Matter for Congressional Consideration
     * [18]Agency Comments and Our Evaluation
     * [19]Appendix I: Objectives, Scope, and Methodology
     * [20]Appendix II: GAO Contact and Staff Acknowledgments

          * [21]GAO Contact
          * [22]Acknowledgments

               * [23]Order by Mail or Phone

Report to the Committee on Finance, U.S. Senate

United States Government Accountability Office

GAO

March 2007

TAX ADMINISTRATION

Additional Time Needed to Complete Offshore Tax Evasion Examinations

GAO-07-237

Contents

Letter 1

Results in Brief 3
Background 4
Offshore Examinations Take Longer Than Other Examinations, so the 3-Year
Statute Can Lead to Lower Assessments Than Would Otherwise Be Possible 7
Some Offshore Examinations Present Enforcement Problems Similar to Those
Where Congress Granted Changes to the Statute 19
Changing the Statute Would Necessitate Weighing Advantages and
Disadvantages 27
Conclusions 30
Matter for Congressional Consideration 31
Agency Comments and Our Evaluation 32
Appendix I Objectives, Scope, and Methodology 33
Appendix II GAO Contact and Staff Acknowledgments 35

Tables

Table 1: Median Development Days by Examination Type, Fiscal Years
2002-2005 9
Table 2: Median Examination Days by Examination Type, Fiscal Years
2002-2005 9
Table 3: Median Total Cycle Time by Case Type, Fiscal Years 2002-2005 10
Table 4: Median Assessments by Examination Type, Fiscal Years 2002-2005 10
Table 5: Assessment Dollars per Examination Hour by Examination Type,
Fiscal Years 2002-2005 11
Table 6: Disposition of Cases When a Disciplinary Action Stemming from a
Barred Statute Was Initially Recommended, Fiscal Years 2005-2006 12
Table 7: Views of Interested Parties in General on Changing the Statute
for Offshore Examinations 28
Table 8: Views of Interested Parties on Design Options for Changing the
Statute for Offshore Examinations 29

Figures

Figure 1: Notional Representation of IRS Audit Selection Process 6
Figure 2: Median Assessment Amount by Number of Examination Days, All
Examinations Closed with an Assessment, Fiscal Years 2002-2005 15
Figure 3: Median Assessment Amount by Number of Examination Days, Field
Examinations Closed with an Assessment, Fiscal Years 2002-2005 16

Abbreviations

AIMS Audit Information Management System ATS abusive tax shelter FTB
California Franchise Tax Board IBC international business corporation IRC
Internal Revenue Code IRS Internal Revenue Service LAO California
Legislative Analyst's Office LDC Lead Development Center LLC limited
liability corporations LLP limited liability partnership SB/SE IRS Small
Business/Self Employed division TIGTA Treasury Inspector General for Tax
Administration

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separately.

United States Government Accountability Office
Washington, DC 20548

March 30, 2007

The Honorable Max Baucus
Chairman
Committee on Finance
United States Senate

The Honorable Charles E. Grassley
Ranking Member
Committee on Finance
United States Senate

In recent years, the Internal Revenue Service (IRS) has observed a
significant increase in offshore activity among U.S. taxpayers. More and
more taxpayers have been observed attempting to "expatriate" their income
and assets. Making investments or doing business internationally is legal,
but numerous schemes have been devised in which the true ownership of
income streams and assets has been hidden or disguised using offshore
activity, which is not legal. Some schemes can be as simple as taking
unreported income and personally traveling to a tax haven country and
depositing the cash into a bank account. Other schemes are more elaborate,
involving numerous domestic and foreign trusts, partnerships, nominees,
foreign financial accounts, offshore credit/debit cards, and multilayered
transactions. Like all forms of noncompliance, offshore schemes add to the
tax gap--the difference between taxes owed and taxes paid on time--and
shifts more of the tax burden onto compliant taxpayers. Such schemes also
can fuel a perception that the tax system is not equitable and can erode
honest taxpayers' faith in the voluntary compliance system. When IRS
discovers an offshore scheme, it has 3 years from when the tax return was
filed in which to work on uncovering the scheme and assessing any
additional tax. This is known as the 3-year statute of limitations on
assessments.

In recognizing the serious problem posed by offshore tax evasion, you
asked us to identify any impediments that may exist to better combating
these schemes. An IRS study shows lengthy examination times for some
offshore examinations, which suggests that time or the lack thereof could
be an impediment to effectively addressing offshore schemes. This report
focuses on this possible impediment. Our objectives were to (1) compare
the length of and recommended assessments yielded by offshore and
nonoffshore examinations and determine whether the 3-year statute of
limitations reduces recommended offshore assessments, (2) determine
whether or not enforcement problems posed by offshore examinations are
similar to enforcement problems that led Congress to grant exceptions to
the statute in other situations, and (3) identify possible advantages and
disadvantages of an exception to the statute for offshore examinations.

To do our work, we (1) analyzed IRS data, reports, publications, and other
documentation providing insight into the characteristics, complexity, and
size of the offshore tax evasion problem;^1 (2) compared IRS data on the
amount of time required to complete examinations involving an offshore
component^2 with those lacking such a component and the recommended
assessments from those examinations; (3) reviewed selected IRS files to
illustrate examinations of returns involving offshore components; (4)
researched the history of the federal statute of limitations for
assessments to include legislation proposed between 2003 and 2006 that
included references to either offshore tax evasion or the statute of
limitations; (5) interviewed representatives of California's taxing
authority, the California Franchise Tax Board (FTB), and reviewed
documents related to a recent change in California's statute related to
certain abusive tax shelters; (6) interviewed revenue agents and managers
with expertise in offshore cases to develop an understanding of IRS
enforcement activities; and (7) interviewed IRS officials and others in
the tax practitioner and policy communities about their views on extending
the examination period for returns involving offshore schemes. We assessed
the reliability of the IRS data that we used and found that it was
sufficiently reliable for our purposes. The universe of IRS examinations
with an offshore component included individual taxpayers, smaller and
larger corporations, and other taxable entities. The database of all
nonoffshore examinations we used for comparison similarly included a full
range of taxpayers. Details on our methodology can be found in appendix I.
We did our work from June 2005 through February 2007 in accordance with
generally accepted government auditing standards.

^1Tax evasion is any method of willfully avoiding or reducing taxes that
is not permitted by law. Tax evasion is distinguished from "tax avoidance"
which denotes the legal interpretation of the tax laws to legitimately
minimize tax liability. In this report, we use the term "tax evasion" to
describe the target of the actions IRS takes to (1) identify underreported
or unreported tax liabilities, either as a result of tax evasion or
abusive transactions or claims subject to disallowance under existing law,
and (2) assess the correct amount of taxes owed by the taxpayer and any
penalties that may apply. Separate from the assessment of taxes owed by
the taxpayer, tax evasion is itself a crime punishable under IRC 7201.

^2IRS assigns a "project code" to those examinations whose main component
is offshore tax evasion, and for the purposes of this review, those case
files with one of six offshore project codes are considered offshore tax
evasion.

Results in Brief

Identifying possibly noncompliant returns, gathering appropriate evidence,
and completing an examination takes much more time for IRS for tax returns
involving abusive offshore transactions than other types of returns. Where
IRS is able to complete examinations involving abusive offshore
transactions, they generally result in larger assessments than other types
of examinations. IRS officials told us that because the same 3-year
statute of limitations that applies to nonoffshore examinations applies to
offshore examinations, the additional time needed to complete an offshore
examination means that IRS sometimes has to end offshore examinations
before the examination is complete, and sometimes chooses not to open an
examination at all, despite evidence of likely noncompliance. Although
data were not available to measure the effect of the statute of
limitations on assessments, IRS revenue agents and their managers told us
that overall assessments for offshore examinations are lower than they
would be if IRS had more time to work these examinations.

Some offshore examinations exhibit enforcement problems similar to those
where Congress has granted a change or exception to the statute in the
past. For example, the issues that led to the creation of the statute
exception for certain abusive tax shelters are similar to those exhibited
by offshore examinations. Past statute changes and exceptions provide
precedent for changing the statute for offshore examinations.

Through discussions with IRS officials and others in the tax practitioner
and policy communities, we identified both advantages and disadvantages of
extending the statute of limitations. Among the advantages were increased
flexibility for IRS to direct enforcement resources to egregious cases of
noncompliance and a possible deterrent effect against future
noncompliance. Disadvantages included increased uncertainty and lack of
closure for taxpayers as well as increased taxpayer perceptions of
unfairness unless an extension to the statute for assessments is matched
by an extended refund period. Our commenters also discussed design options
to mitigate some of the disadvantages of the statute extension, such as
making an exception apply to all taxpayers having offshore
accounts/entities, and thereby, mitigating taxpayer uncertainty and lack
of closure. Maintaining symmetry between the statutes for assessments and
refunds was also mentioned as mitigating taxpayer perceptions of
unfairness about extending the statute for assessments.

In this report, we suggest that Congress make an exception to the 3-year
civil statute assessment period for taxpayers involved in offshore
financial activity. In comments on a draft of this report, IRS officials
commented that a longer statute for offshore examinations makes sense and
should enhance compliance. IRS also provided comments on several technical
issues and legal issues, which we incorporated in this report where
appropriate.

Background

It is perfectly legal for U.S. taxpayers to hold money offshore. It is
illegal, however, for a taxpayer to not disclose substantial offshore
holdings, to not report income earned in the United States and "hidden"
through offshore arrangements, and to not report income earned offshore to
IRS on the taxpayer's tax return. If U.S. taxpayers own an offshore
business such as a foreign corporation, they are required to disclose that
holding to IRS on their tax return. When applied to abusive transactions,
IRS generally uses the term "offshore" to mean a country or jurisdiction
that offers financial secrecy laws in an effort to attract investment from
outside its borders.^3 When referring to a financial institution,
"offshore" refers to a financial institution that primarily offers its
services to persons domiciled outside the jurisdiction of the country in
which the financial institution is organized.

Abusive offshore schemes are often accomplished through the use of limited
liability corporations (LLC), limited liability partnerships (LLP),
international business corporations (IBC), and trusts, foreign financial
accounts, debit or credit cards, and other similar instruments. According
to IRS, the schemes can be complex, often involving multiple layers and
multiple transactions used to hide the true nature and ownership of the
assets or income that the taxpayer is attempting to hide from IRS.

IRS has multiple programs and techniques used to select potentially
noncompliant tax returns for examination. One source is a computer model
designed to predict returns that, if audited, would be most likely to
result in additional taxes owed. Other sources that prompt an examination
include referrals from inside or outside IRS, information from third
parties, and indications of fraud or noncompliance from other audits. Once
IRS has identified a return for an examination, the classification process
begins. Classification is the process of determining whether a return
should be selected for examination, what issues should be examined, and
how the examination should be conducted. IRS guidance on classification
states that classification should be conducted by an experienced examiner.

^3IRS officials noted that although many enforcement problems occur in
certain foreign jurisdictions that are characterized by strict financial
privacy regimes, the term "offshore" broadly includes the activities of
U.S. taxpayers in all foreign transactions.

Examination is the accumulation of evidence for evaluating the accuracy of
the taxpayer's tax return. Examiners gather facts to correctly determine a
taxpayer's tax liability. Evidence can include the taxpayer's testimony
and books and records as well as the examiner's own observations and
documents from third parties. Methods for accumulation of evidence include
analytical tests, documentation, inquiry, inspection, observation, and
testing. IRS procedures call for examiners to pursue an examination to the
point where a reasonable determination of correct tax liability can be
made. In turn, examiners prepare audit reports, which should contain all
information necessary to ensure a clear understanding of the adjustment,
if any, and document how the tax liability was computed. These reports
serve as the basis for assessment actions. An assessment records the
taxpayer's liability due.^4

IRS examinations are generally of one of three types--correspondence,
office, or field. The simplest examinations usually cover one to two tax
issues handled by a lower-graded examiner through correspondence. More
complex examinations are done by meeting with taxpayers or their
representatives in IRS offices. The most complex examinations are done
through revenue agent field visits to taxpayer locations. Only about 16
percent of all IRS examinations from 2002 through 2005 were conducted
through field examinations, but 98 percent of offshore examinations were
of this type. About three-fourths of nonoffshore examinations are handled
through correspondence.

IRS does not classify every return that is filed, nor does it examine
every case file that is classified, even if IRS determines that examining
the tax return would likely yield an assessment of additional taxes owed.
Figure 1 provides a notional representation of the process of taking the
over 130 million individual income tax returns that were filed in fiscal
year 2004 through the steps that lead to audits of a much smaller number
of those returns.

^4Analyses in this report involve recommended assessments at the close of
the examination. Recommended assessment amounts can be reduced if the
taxpayer takes his or her case to IRS Appeals or to Tax Court.

Figure 1: Notional Representation of IRS Audit Selection Process

In most cases, the law gives IRS 3 years from the date a taxpayer files a
tax return to complete an examination and make an assessment of any
additional tax. For example, if a taxpayer filed a tax return on April 15,
2000, IRS had until April 15, 2003, to finish any examination of that
return and make an assessment of additional taxes owed by the taxpayer.
This statute of limitations for assessments is in effect for all
examinations with exceptions allowing longer periods for certain taxpayer
actions or omissions such as fraud or substantial understatement of gross
income (in excess of 25 percent of the amount of gross income stated on
the return). Taxpayers may also waive the 3-year assessment limitation
through written consent.

Offshore Examinations Take Longer Than Other Examinations, so the 3-Year Statute
Can Lead to Lower Assessments Than Would Otherwise Be Possible

In general, it takes longer for IRS to identify and examine tax returns
involving abusive offshore transactions than IRS needs in nonoffshore
cases because of the added complexity of examining offshore transactions.
Where IRS is able to complete examinations involving abusive offshore
transactions, they generally result in larger assessments than other types
of examinations. IRS has policies in place to avoid violating the statute
of limitations, and IRS enforcement personnel told us that these policies,
in conjunction with the longer time needed to complete offshore
examinations, mean some cases are never opened in the first place while
others are not fully worked because the time allowed under the current
statute is running out. As a result, they said, overall assessments for
offshore cases are lower than they would be if IRS had more time to work
these cases.

Offshore Cases Take Longer for IRS to Develop and Examine

IRS officials told us that cases involving offshore tax evasion present
special, time-consuming challenges that other types of cases do not. Tax
evasion, both domestic and offshore, often involves schemes with many
layers of deception. IRS officials told us that for domestic tax evasion,
revenue agents are able to issue summonses to domestic financial
institutions to uncover the layers of deception the taxpayer created to
hide the source and existence of the funds. In offshore cases, IRS
generally does not have summons power over offshore financial
institutions, and is often unable to determine the owner of an offshore
account or business, or determine the source of the funds. Even in cases
where IRS is able to determine information about offshore funds, an IRS
manager told us that this process of discovery is much more time consuming
than for nonoffshore cases.

Unlike much nonoffshore tax evasion, most possible offshore tax evasion
cases are not discovered through IRS's computerized analysis of tax
returns, but rather through investigations of promoters of offshore
schemes. Officials told us that several divisions of IRS forward leads on
the promoters of offshore schemes they discover to revenue agents, who
develop the cases in order to discover the extent of the promoter's use of
offshore schemes. This process takes far longer than computer
analysis-based methods of identifying potential noncompliance.

After developing information that a promoter of offshore schemes illegally
sold schemes to help taxpayers avoid their tax liability, IRS can refer
that information to the Department of Justice, which can then file a
complaint in the United States District Court requesting the court to
issue an injunction against the promoter. In some cases, the injunction
will compel the promoter to disclose the clients who purchased the scheme.
IRS officials told us that it can take years to get a client list from a
promoter and, even with a client list, there is still much work that IRS
needs to do before the clients of the offshore schemes can be audited. For
example, IRS officials told us that they may only get limited information
about the clients of offshore promoters, and often that information is
limited to a name and perhaps the city and state where the client lives,
so considerable time may be spent finding the individuals listed by the
promoter.

Time spent developing information on a return before putting it into the
queue for examination shortens the time available to close the examination
before the 3-year civil statute of limitations expires. Table 1 compares
the median number of days spent in development for offshore and
nonoffshore examinations from 2002 to 2005.^5 As shown in the table, the
median offshore case took 184 more calendar days than the median
nonoffshore case to move from filing to examination. Comparing just field
examinations, which constituted over 98 percent of offshore examinations
in fiscal years 2002 through 2005, the difference in median development
time was 96 days. Some examinations lead to additional examinations of the
same taxpayer's returns, such as when a revenue agent identifies
noncompliance on one return and then reviews prior year returns looking
for the same problem, or when a taxpayer files a new return while an
examination is underway. To avoid overstating development time, this
comparison includes only the number of days between the start of the
examination and the filing date of the last return filed before the
examination began.^6

5A small number of examinations take an especially short or an especially
long time to develop and complete. Because of this, we generally use
medians in this report as the representation of the central tendency of
the data we analyzed.

^6Because we chose to count development time for only the return filed
immediately before the examination start date, the median development time
information in table 1 understates development time for examinations that
were in fact prompted by an earlier return from the same taxpayer. This
makes our estimate of development time conservative for both offshore and
nonoffshore examinations.

Table 1: Median Development Days by Examination Type, Fiscal Years
2002-2005

                    Median days in development,   Median days in development, 
Examination type            all examinations       field examinations only 
Offshore                                 504                           504 
Nonoffshore                              320                           408 

Source: GAO analysis of IRS data.

Note: Medians in this table are not based on analysis of all examinations.
Our calculations included only one examination where a single taxpayer is
the subject of two or more related examinations.

Once offshore cases are developed and moved into examination, the
examinations take longer than nonoffshore cases. Considering all types of
examinations together, the median offshore examination took 90 more days
than the median nonoffshore examination. Considering field examinations
alone, the median offshore field examination was 70 days longer than the
median nonoffshore field examination, as shown in table 2. IRS officials
told us that this is due to examination complexity and the difficulty of
identifying and obtaining information from foreign sources.

Table 2: Median Examination Days by Examination Type, Fiscal Years
2002-2005

                                             Number of                        
               Total number Median number        field                        
Examination           of  of days, all examinations Median number of days, 
type        examinations  examinations         only     field examinations 
Offshore           6,720           275        6,597                    279 
Nonoffshore    4,134,870           185      653,239                    209 

Source: GAO analysis of IRS data.

The total time that elapses between a return being filed and IRS's closing
of the examination of that return is referred to as total cycle time and
provides another type of comparison between offshore and nonoffshore
cases. As shown in table 3, the median offshore examination took almost
500 more calendar days overall to close than the median nonoffshore
examination, a 126 percent difference. The median offshore case took 82
percent of the statute time versus 36 percent for nonoffshore cases.
Considering just field examinations, the median cycle times for offshore
and nonoffshore examinations were closer in length, but the median
offshore examination was still 194 days longer, a difference of 28
percent.

Table 3: Median Total Cycle Time by Case Type, Fiscal Years 2002-2005

                      All examinations             Field examinations only
                                 Percentage of                  Percentage of 
               Median cycle  statute time used       Median statute time used 
                   time, in    by IRS to close  cycle time,   by IRS to close 
Case type           days               case      in days              case 
Offshore             896                 82          896                82 
Nonoffshore          397                 36          702                64 

Source: GAO analysis of IRS data.

Note: The median day figures in tables 1 and 2 are drawn from different
populations, so they do not add up to the median day figures in table 3.

Completed Offshore Examinations Yield Larger Recommended Assessments Than Other
Examinations

About half of all offshore examinations resulted in a recommended
assessment of additional taxes due compared to approximately 70 percent of
nonoffshore examinations. While less frequent, assessments from all types
of offshore examinations--correspondence, office and field--had a median
that was nearly 3 times larger than from nonoffshore examinations.
Considering just field examinations, recommended assessments from offshore
examinations also had a median that was much larger than nonoffshore
examinations, though by a smaller margin, as shown in table 4.

Table 4: Median Assessments by Examination Type, Fiscal Years 2002-2005

                       All examinations             Field examinations only
                           Number of                    Number of             
                        examinations      Median     examinations      Median 
Examination       resulting in an assessment,  resulting in an assessment, 
type                   assessment  in dollars       assessment  in dollars 
Offshore                    3,247       7,933            3,166       7,848 
Nonoffshore             2,899,957       2,877          359,272       4,529 

Source: GAO analysis of IRS data.

While yielding larger assessments, the greater amount of time spent on
offshore examinations means that their yield per hour of direct
examination time is lower.^7 Considering all types of examinations
together, including both those that resulted in an assessment and those
that did not, offshore examinations yielded less per hour of direct
examination time than nonoffshore examinations because the number of hours
spent on those examinations is nearly 4 times longer, on average. From
2002 to 2005, IRS examiners spent an average of 46 hours on all types of
offshore examinations, compared to an average of only 12 hours for all
types of nonoffshore examinations. Considering only field examinations,
average hours per examination were 47 for offshore examinations versus 62
for nonoffshore examinations, and the difference in dollars per hour of
direct examination time is greater.^8

7Direct examination hours are different from total cycle time or
examination days in that they do not include time between actions by IRS,
such as time spent waiting for a response from the taxpayer or from a
financial institution.

Table 5: Assessment Dollars per Examination Hour by Examination Type,
Fiscal Years 2002-2005

               Total dollars per hour of                                      
                      examiner time, all   Total dollars per hour of examiner 
                            examinations        time, field examinations only 
Offshore                        1,084                                1,073 
Nonoffshore                     2,156                                2,824 

Source: GAO analysis of IRS data.

Note: Unlike table 4, table 5 considers all examinations, including those
that did not result in an assessment.

To Prevent Violating the Statute of Limitations, IRS Does Not Pursue Some Likely
Offshore Tax Evasion

IRS has strict policies to prevent examinations from going past the
statute of limitations because if an assessment is not made within 3
years, the statute of limitations bars IRS from making any assessment at
all. Such instances mean the loss of revenue to IRS and inefficient use of
IRS examination resources. IRS policies specify that statute expiration
dates for all tax returns be properly determined, that all records be
annotated with these dates, and that the cases be closely monitored to
prevent accidentally running out of time. Revenue agents and managers told
us that IRS strongly emphasizes the importance of keeping track of these
dates and avoiding allowing an examination to go past the statute date.

While the 3-year statute of limitations applies in most cases, some
exceptions exist under current law. For example, an assessment may be made
after the 3-year point if the tax return is false or fraudulent or if
there is a sufficiently large omission of gross income. Taxpayers may also
agree to waive their statute rights.

^8The average of direct time charges on nonoffshore field examinations is
affected by a small number of examinations that are both very time
intensive and result in very high recommended assessments. We used
averages in this comparison because hours per nonoffshore examination are
influenced by the large number of very short correspondence examinations,
resulting in a median of only 1 hour per case.

In the rare cases where IRS personnel allow an examination to go past the
statute without meeting one of the current exceptions to the statute (a
"barred statute"), the responsible agent and his or her manager must
prepare a Barred Statute Report and face possible disciplinary action
because of the examination time spent with no possibility of making an
assessment. IRS data for fiscal years 2005 and 2006 showed 39 barred
statutes associated with examinations where a manager made an initial
determination to recommend a disciplinary action. As shown in table 6,
most of these barred statutes ultimately resulted in some type of
disciplinary action.

Table 6: Disposition of Cases When a Disciplinary Action Stemming from a
Barred Statute Was Initially Recommended, Fiscal Years 2005-2006

Disciplinary action                 2005 2006 Total 
No action, withdrawn, closed           3    1     4 
Counseling, admonishment, reprimand   20   11    31 
Suspension, removal, resignation       3    1     4 
Total                                 26   13    39 

Source: GAO analysis of IRS data.

Note: These disciplinary actions include all types of examination cases,
both offshore and nonoffshore.

IRS has created guidance for continuing offshore examinations past the
3-year point. This guidance permits agents to request permission to carry
on the examination past the 3-year point based on their judgment that,
given additional time, they will be able to ultimately prove that the
examination meets one of the following three conditions:^9

           1. The return is false or fraudulent. IRS defines false or
           fraudulent as the preparation and filing of false income tax
           returns by claiming inflated personal or business expenses, false
           deductions, unallowable credits, or excessive exemptions.
           2. There is a sufficiently large omission of gross income (in
           excess of 25 percent of the amount of gross income stated on the
           return) under IRC 6501(e), in which case the tax may be assessed
           at any time within 6 years after the return is filed.
           3. The taxpayer failed to notify the Secretary of the Treasury of
           certain foreign transfers under IRC 6501(c)(8), in which case the
           statute of limitations is 3 years from the date IRS receives the
           required information.^10

^9Other exceptions to the statute are in law. These three exceptions are
specified in this guidance for carrying an examination past the 3-year
statute date without first definitively proving that one of the statute
exception conditions applies. IRS may also continue an examination past
the 3-year point when taxpayers agree to waive their statute rights.

A conclusion to continue an examination beyond the statute must be
approved in writing by IRS managers, based on the revenue agent's
documentation of the rationale and calculations to support this
conclusion. In addition, IRS must have made a timely and proper request to
the taxpayer to obtain a consent agreement to extend the statute. The
taxpayer's refusal to extend the statute or lack of response must be
documented. If this guidance is followed, no disciplinary action will be
taken against the IRS managers and agents if the examination ultimately
does not prove to meet one of the three conditions for making an
assessment after 3 years.

The IRS guidance allowing some examinations to go past the normal statute
period based on the revenue agent's judgment that an assessment will be
possible after the 3-year point recognizes the limited time available to
agents to finalize case-specific facts when the 3-year statute is about to
expire. The IRS guidance also notes that the Credit Card Summons project
examinations are generally likely to involve unreported income or fraud as
well as failure to file information returns reporting foreign transfers.
The guidance also states that other offshore examinations share many of
the same challenges as Credit Card Summons project examinations including
complex examinations and securing documents located outside the United
States.^11

10This exception is limited to just certain transfers associated with
foreign corporations, partnerships and trusts. The exception is further
limited to specific issues related to transactions with these foreign
entities, such as the organization or reorganization of foreign
corporations and the acquisition of their stock.

^11At the time of our review, IRS had six offshore projects--Credit Card
Summons, Offshore Transactions, Offshore Compliance Initiative Project,
Foreign Trusts, Amended Returns with Offshore Voluntary Compliance Issues,
and the Offshore Compliance Project.

IRS managers told us that this procedure for continuing examinations
beyond the statute is cumbersome, time-consuming, and some agents are
reluctant to use the procedure because of concerns about barred statutes.
Revenue agents told us that this reluctance stems from the culture of IRS
examiners where agents are instructed from the time they are hired to
never let an examination go past the statute of limitations for any
reason. Despite subsequent assurances from IRS guidance, however, revenue
agents told us that ingrained reluctance to letting the statute of
limitations pass is still paramount.

All of the examinations allowed to extend past the statute date under this
guidance represent a gamble on the part of IRS that the examination will
ultimately meet one of the exceptions to the statute and an assessment
will be allowed under the law. IRS records show that 1,942 offshore
examinations were taken past the 3-year statute period from fiscal years
2002 through 2005. IRS ultimately made assessments on 63 percent of these
examinations and these assessments were significantly higher than
assessments from all other types of examinations, with a median assessment
of about $17,500 versus about $5,800 from offshore examinations that were
closed within the 3-year statute of limitations and $2,900 from all
nonoffshore examinations closed within 3 years.^12 IRS databases do not
allow systematic analysis of the approximately 700 examinations that did
not result in an assessment, so we do not know if these were accurate
returns or if the discovered tax evasion just did not rise to the level of
fraud or substantial understatement of income.

For those examinations that closed with an assessment, longer examinations
did not change the median assessment amount significantly for nonoffshore
examinations. On the other hand, offshore examinations produced much
larger median assessments than both shorter offshore examinations and all
nonoffshore examinations when the examinations themselves took 3 years or
more, as shown in figure 2. A similar relationship is found for field
examinations alone, as shown in figure 3.

^12Considering only field examinations, median assessments from offshore
examinations during this period that resulted in an assessment were very
similar--about $17,300 from examinations that took longer than 3 years and
$5,800 from examinations closed in less than 3 years. For nonoffshore
examinations, field examinations that took longer than 3 years had a
median recommended assessment of about $14,000 and those closed within 3
years had a median recommended assessment of about $3,900.

Figure 2: Median Assessment Amount by Number of Examination Days, All
Examinations Closed with an Assessment, Fiscal Years 2002-2005

Figure 3: Median Assessment Amount by Number of Examination Days, Field
Examinations Closed with an Assessment, Fiscal Years 2002-2005

Similarly, our analysis of assessment dollars generated per hour of
examination time (including examinations both with and without
assessments) showed that the yield increased markedly for offshore
examinations that take more than 3 years. While average assessment dollars
per hour of direct offshore examination time are about half of the average
for nonoffshore examinations, the reverse is the case for examinations
that go over three years--$6,458 per hour for offshore examinations
compared to $3,432 per hour for nonoffshore examinations. The comparison
is nearly the same for field examinations alone--$6,465 per hour for
offshore field examinations and $3,454 per hour for nonoffshore field
examinations.

Revenue agents and managers told us that some developed case files are not
opened for examination because insufficient time remains under the statute
to make the examination worthwhile. They said that managers and agents
have leeway in deciding which examinations to work because there are
usually more developed case files waiting for agents than there are agents
to work them. IRS wants agents to work examinations with a good likelihood
of leading to meaningful assessments; managers told us they look for
examinations that have both apparent noncompliance and sufficient time
remaining within the statute to fully develop the apparent issues. Revenue
agents and IRS managers told us that, in order to avoid violating the
statute, they will often choose case files to examine with more time
remaining under the 3-year statute of limitations over case files with
less time remaining but with more likely or more substantial possible
assessments. As a result, they explained that not all case files in the
unassigned inventory of case files developed for examination are selected
for examination and many case files are "surveyed," or closed without
examination.^13

Two IRS policies could contribute to closing a developed offshore case
without an examination. One of these policies requires sorting the
unassigned inventory to identify the areas most in need of examination.
This policy includes statute year and statute date among the attributes
used in sorting unassigned inventory. A second policy requires that an
examiner not begin an examination or requisition any return for audit
without management approval if fewer than 12 months remain on the
statutory period for assessment. As described earlier, offshore
examinations typically require more time to develop than nonoffshore
examinations, and as a result, offshore examinations in the queue for
examination would typically be nearer the end of the assessment period
than nonoffshore examinations. IRS managers explained that this attribute
of offshore examinations can lead to leaving offshore cases in the queue
until the statute period ends and then closing the case without an
examination.

Agents and managers also said that they often choose to end an ongoing
examination nearing the end of the 3-year assessment period without making
a complete assessment rather than risk taking the examination past the
statute period, losing revenue, and facing disciplinary action. IRS agents
and managers told us that they face difficult choices as an examination
nears the end of the 3-year assessment period and the examination is
incomplete. On the one hand, the examination can be discontinued. This
choice is the safest for individual IRS agents and managers because it
avoids the possibility of a Barred Statute Report and disciplinary
actions. However, this choice also results in an assessment that does not
accurately reflect the extent of a taxpayer's compliance or noncompliance
with tax laws because the examination is incomplete. Continuing the
examination can result in an accurate assessment, but only if the
examination demonstrates one or more of the exceptions to the statute
described earlier. If the examination does not ultimately demonstrate
fraud or another basis for an exception, IRS managers and agents wasted
IRS resources because they are barred from making an assessment. Revenue
agents told us that they believed that in some cases there is "money being
left on the table" in the form of unexamined issues that could have led to
assessments if there had been sufficient time to examine them.

^13Survey decisions can be made at several levels of management and may
also be made by individual agents.

Even where there is sufficient time to work an examination, only a few
years where a taxpayer was using a particular scheme may be open to
examination and the early years of a scheme may be past their statute date
before the examination even begins. For example, if IRS is examining a
taxpayer's 2005 tax return and discovers a significant understatement in
the income that the taxpayer reported, the agent can examine some of the
taxpayer's previous returns, but unless the revenue agent and manager
suspect fraud, in which case there is not a statute of limitations, IRS
must abide by the 3-year statute of limitations on assessments and not
examine some prior years that taxpayers held money offshore illegally. A
senior IRS official told us that this is a particularly significant
problem because it is often in the first years of an offshore scheme where
the taxpayer moves the most money offshore and the most egregious tax
evasion takes place, so IRS is missing out on significant assessments by
not being able to look back at previous tax returns.

IRS revenue agents are not able to accurately estimate likely possible
assessments for case files or tax years that are unexamined. Similarly, in
cases where an examination is started and subsequently closed without some
issues being examined due to the statute of limitations, it is not
possible to estimate the likely assessment from unexamined issues.

As mentioned earlier, however, we found that 1,942 offshore examinations
were allowed, either by IRS decision or by a voluntary statute extension
signed by the taxpayer under examination, to exceed the 3-year statute of
limitations. Of those, more than 700 were closed without an additional tax
assessment. IRS officials told us that many of the offshore examinations
that go past the 3-year statute of limitations are very difficult to work
due to complex financial arrangements and that even with significantly
more time, some particularly complex and well-hidden offshore schemes
would remain very difficult to uncover. IRS data did not show the reasons
that the 700 offshore examinations that went past the 3-year statute of
limitations were closed without an assessment.

Some Offshore Examinations Present Enforcement Problems Similar to Those Where
Congress Granted Changes to the Statute

Some offshore examinations exhibit compliance problems similar to those
where Congress granted a change or exception to the statute in the past.
Offshore examinations take longer than nonoffshore examinations for IRS to
develop and examine for reasons such as technical complexity and the
difficulty of obtaining information from foreign sources, and as a result,
IRS may not complete assessments of all taxes owed. These problems are
similar to problems giving rise to other changes and exceptions to the
statute at both the federal and state levels over the years. These changes
and exceptions provide precedent for changing the statute for offshore
examinations.

Offshore Enforcement Problems Are Similar to Those Justifying Past Changes to
the Statute

Offshore examinations present IRS with various enforcement problems. As
discussed above, offshore examinations take longer to develop and examine.
IRS officials told us that this is due to the examinations' complexity and
difficulty in identifying and obtaining information from foreign sources.
Agents and managers also said that they often choose to end an ongoing
examination nearing the end of the 3-year assessment period without making
a complete assessment rather than risk taking the examination past the
statute period, losing revenue, and facing disciplinary actions. Further,
agents and managers explained that some taxpayers or their representatives
employ dilatory, uncooperative tactics when dealing with IRS. In addition,
we previously testified^14 that the use of offshore schemes can also pose
a threat to the integrity and fairness of our tax system by adversely
affecting voluntary compliance if honest taxpayers believe that
significant numbers of individuals are not paying their fair share of the
tax burden.

We reviewed 12 IRS offshore case files and found examples of (1) technical
complexity, (2) difficulty in identifying and obtaining information from
foreign sources, and (3) taxpayers or their representatives employing
dilatory, uncooperative tactics when dealing with IRS. We also found a
wide variety of offshore examinations, from very simple examinations to
much more complex examinations that had been under examination for years.
In order to obtain illustrative examples of offshore examinations, we
reviewed examinations that took a shorter than average number of days to
complete, about an average number of days, and a longer than average
number of days. We reviewed case files in two locations and our reviews
included both completed examinations and examinations still in progress.
These examinations included some that had no changes to the taxpayer. The
two examinations described below include one that took a relatively low
number of days and one that took a longer than average number of days.

^14GAO, Internal Revenue Service: Enhanced Efforts to Combat Abusive Tax
Schemes--Challenges Remain, [24]GAO-02-618T (Washington, D.C.: Apr. 11,
2002).

In the first examination, the taxpayer was identified as holding an
offshore credit card in a country considered to be a tax haven. The
taxpayer maintained that he did not have an offshore credit card. IRS used
a summons to obtain records of a domestic rental car transaction that
would identify the holder of the offshore credit card. While the name
shown on the rental car records was similar to the taxpayer's name, it was
not the taxpayer's name. After reviewing the rental car records, the
revenue agent concluded that the taxpayer was not the holder of the
offshore credit card. The examination had no other issues and resulted in
no change in the amount of tax owed by the taxpayer. In conducting this
examination, the revenue agent

           o sent 4 pieces of correspondence to the taxpayer,
           o conducted 1 interview with taxpayer,
           o notified the taxpayer of third-party contact, and
           o used 1 summons to obtain domestic rental car records; the
           summons was returned 33 days after it was issued.

           In the second examination, the taxpayer had a number of businesses
           in the United States and in other countries, including at least
           one business in a tax haven country. It appeared that some of the
           taxpayer's businesses paid consulting fees to other businesses the
           taxpayer owned, and consulting fees were paid into an offshore
           account in a tax haven country through which the taxpayer received
           funds via a credit card.

           IRS found it difficult to determine how much money was in the
           taxpayer's offshore tax haven business and how the money got
           there. The money in that business, IRS told us, is the lynchpin of
           the entire examination, which was still underway at the time of
           our review. During the 4 years that the examination had been
           underway, IRS opened examinations on the taxpayer's spouse and on
           other businesses in other tax years. IRS has not been able to find
           where some of the money is going, although officials are confident
           that more is being hidden as the taxpayer had other businesses
           that made payments to the business in the offshore tax haven
           country. Over the 4 years of this examination, there have been at
           least

           o 5 powers of attorney,
           o 20 summonses,
           o 39 contacts with the taxpayer's power of attorney,
           o 23 document requests,
           o 5 missed appointments by taxpayer or taxpayer's representative,
           o 1 statute extension,
           o 2 interview requests denied,
           o 5 meetings with taxpayer's representative,
           o 4 postponed appointments,
           o 4 third-party contacts, and
           o 2 occasions on which the taxpayer refused to supply information.

           The scheme began, as far as IRS can tell, in the late-1990s, but
           examinations of some early years of the taxpayer's scheme were
           statutorily barred. This means that, when the examination
           eventually closes, IRS will not be able to assess any additional
           taxes on at least some tax years that IRS agents found the
           taxpayer was holding money offshore unless they determine that
           fraud was committed.

           Enforcement problems exhibited in the 12 cases we reviewed are
           similar to enforcement problems justifying changes and exceptions
           to the statute at both the federal and state levels over the
           years. For example, the statute was recently changed at both the
           federal and state levels to address specific compliance problems,
           such as dilatory tactics on the part of taxpayers and the use of
           technically complex transactions. The following details on
           legislative actions illustrate instances where changes and
           exceptions to the statute were granted at both the federal and
           state levels because of enforcement problems similar to those
           exhibited by offshore examinations such as (1) time constraints on
           IRS; (2) taxpayers delaying examinations through dilatory,
           uncooperative tactics on the part of taxpayers; and (3) failure of
           taxpayers to provide required information.
		   
		   Historical Changes and Exceptions

           The Revenue Act of 1934^15 provided the current 3-year statute. In
           making the change in 1934 from 2 to 3 years, the Senate Report
           noted that experience showed that the 2-year period was "too short
           in a substantial number of large cases, resulting oftentimes in
           hastily prepared determinations, with the result that additional
           burdens are thrown upon taxpayers in contesting ill-advised
           assessments. In other cases, revenue is lost by reason of the fact
           that sufficient time is not allowed for disclosure of all the
           facts."

           As discussed above, Congress has also provided exceptions to this
           3-year assessment period. For example, the exception for filing a
           false or fraudulent return dates back to the Revenue Act of
           1916.^16 Where this exception applies, the assessment can be made
           at any time. Similarly, the exception for significant omissions of
           gross income dates back to the Revenue Act of 1934. Where this
           exception applies, the tax may be assessed at any time within 6
           years after the return is filed. According to the legislative
           history for the 1934 Act, this provision was added to enlarge the
           scope of the existing exception allowed for false or fraudulent
           returns while limiting the exception where a taxpayer may have
           made an honest mistake and it would be unfair to keep the statute
           open indefinitely. The exception to the statute of limitations for
           failure to report certain foreign transactions dates back to the
           Taxpayer Relief Act of 1997.^17 This exception was included and
           grouped along with certain other changes designed to simplify
           formation and operation of international joint ventures.
		   
		   Recent Federal Exception to the Statute

           More recently, Congress changed the statute to provide IRS with
           additional time to make assessments in the case of unreported
           listed transactions.^18 With the American Jobs Creation Act of
           2004,^19 Congress extended the statute for unreported listed
           transactions for 1 year after the earlier of (1) the date the
           information required to be reported is provided or (2) a material
           advisor meets the requirements for providing a list of investors
           in the listed transaction.

           Listed transactions are complex transactions that manipulate parts
           of the tax code or regulations and are typically buried among
           "legitimate" transactions reported on tax returns. Because the
           transactions are often composed of many pieces located in several
           parts of a complex tax return, they are essentially hidden from
           plain sight, which contributes to the difficulty of determining
           the scope of the abusive shelter problem. Often lacking economic
           substance or a business purpose other than generating tax
           benefits, abusive shelters are promoted by some tax professionals,
           often in confidence, for significant fees, sometimes with the
           participation of tax-indifferent parties, such as foreign or
           tax-exempt entities. They may involve unnecessary steps and
           flow-through entities, such as partnerships, which make detection
           of these transactions more difficult. The transactions are
           marketed to wealthy individuals, large corporations, and small
           business taxpayers. Section 6111 of the Internal Revenue Code
           requires the promoter or other tax shelter organizer to report
           such transactions with IRS. Further, Department of the Treasury
           regulations^20 require promoters to maintain lists of investors
           who have entered into the transactions and investors to disclose
           the transactions into which they have entered.

           In a March 2006 report, for example, the Treasury Inspector
           General for Tax Administration (TIGTA) described a type of listed
           transaction called Son of Boss (Bond and Option Sales
           Strategies).^21 According to TIGTA, this transaction used
           flow-through entities, such as partnerships, and various financial
           products to add steps and complexity to transactions that had
           little or no relationship to the investor's business or the asset
           sale creating the sheltered gain. TIGTA further explained that the
           losses generated from the transactions were often reported among
           "legitimate" items in several parts of the tax return. TIGTA
           concluded that taken together, these characteristics, especially
           the use of flow-through entities, made it very difficult for IRS
           to detect the Son of Boss abusive tax shelter through its
           traditional process of screening returns individually for
           questionable items. TIGTA noted that examinations of abusive tax
           shelters can take significant amounts of time even for the most
           experienced examiners because such shelters often involve complex,
           technical transactions that take on different variations and
           require examining multiple flow-through entities to make a proper
           tax determination.

           At the time of our review, IRS representatives stated that
           sufficient time had not elapsed to determine to what extent, if
           any, the 1-year extension for unreported listed transactions
           improved examination effectiveness. An IRS analyst explained,
           however, that the 1-year extension resulted in increased
           disclosures of previously undisclosed listed transactions. This
           analyst stated that 35 taxpayers made 74 separate disclosures
           about previously unreported listed transactions and that 8 of
           these 74 disclosures were duplicates.
		   
		   California Statute Change

           At the state level, California recently extended its statute from
           4 to 8 years for taxpayers that invest in an abusive tax shelter
           (ATS) transaction. Such transactions include IRS listed
           transactions and other schemes of particular importance to
           California. According to the California Legislative Analyst's
           Office (LAO), the key feature of these transactions is that they
           have no true economic purpose but exist solely for reasons of tax
           avoidance. Among their characteristics is the use of (1)
           pass-through entities such as partnerships, (2) third party
           facilitators, and (3) offshore accounts or facilitators. The LAO
           further explained that ATS transactions can be quite difficult to
           identify and often even harder to understand, even for trained tax
           auditors.

           As with IRS, California experienced increased disclosure as a
           result of extending its assessment period from 4 to 8 years for
           taxpayers involved in ATS transactions. A California FTB manager
           stated that the newly enacted 8-year statute had not been applied
           because most tax shelter examinations are closed within the normal
           4-year period or by requesting voluntary waivers. It should be
           noted that California's assessment period is 1 year longer than
           the federal 3-year assessment period. The FTB manager also cited
           two sources of examinations in which the normal 4-year statute had
           expired but taxpayers were willing to work to resolve their tax
           shelter issues. These sources were the Self Compliance Letters^22
           and the California Tax Shelter Resolution Initiative.^23 The
           California FTB used a self compliance letter to solicit amended
           returns from taxpayers for at least 1 year in which the 4-year
           statute had expired. This letter cited the 8-year statute. At the
           time of our review, 13 taxpayers filed amended returns, which
           reported tax and interest of about $2.3 million. Additional
           penalties may apply to these 13 taxpayers. Another 48 taxpayers
           agreed to file amended returns with estimated taxes and penalties
           of about $7 million. Under the California Resolution Initiative,
           the FTB was accepting applications and drafting closing agreements
           with another 181 taxpayers who had at least 1 tax year for which
           the 4-year statute had either expired or was about to expire.
		   
		   Legislative Reports Discuss Reasons for Change

           The justification for extending the statute for unreported listed
           transactions at the federal level and for ATS transactions in
           California generally involved qualitative factors. A House of
           Representatives Report^24 accompanying the American Jobs Creation
           Act of 2004 states that "some taxpayers and their advisors have
           been employing dilatory tactics and failing to cooperate with IRS
           in an attempt to avoid liability because of the expiration of the
           statute of limitations. The Committee accordingly believes that it
           is appropriate to extend the statute of limitations for unreported
           listed transactions."

           While not enacted, Senate bill 476 (CARE Act of 2003) included a
           provision similar to the provision of the American Jobs Creation
           Act of 2004 that extended the statute for unreported listed
           transactions. A Senate Report^25 accompanying Senate bill 476
           states that "...extending the statute of limitations if a taxpayer
           required to disclose a listed transaction fails to do so will
           afford IRS additional time to discover the transaction if the
           taxpayer does not disclose it." Similarly, the California LAO
           stated that the time extension for ATS transactions will allow the
           FTB to "more fully develop cases that represent ATS activity and
           result in a greater sustainment rate at the appeal level."

           In addition to affording more time for IRS to discover undisclosed
           transactions, the Senate report accompanying Senate bill 476 also
           stated that "extending the statute of limitations if a taxpayer
           required to disclose a listed transaction fails to do so will
           encourage taxpayers to provide the required disclosure...." In
           analyzing the legislation that extended the California assessment
           period from 4 to 8 years, the California FTB noted that "some
           taxpayers will continue to engage in tax avoidance transactions
           until the risks and costs of engaging in the transactions are
           significantly increased."

           More generally, tax evasion by some taxpayers can affect the
           perceptions of other compliant taxpayers about the fairness and
           equity of our tax system. In its report accompanying Senate bill
           476, the Senate Committee on Finance stated that the committee "is
           aware that individuals and corporations are increasingly using
           sophisticated transactions to avoid or evade Federal income tax.
           Such a phenomenon could pose a serious threat to the efficacy of
           the tax system because of both the potential loss of revenue and
           the potential threat to the integrity of the self-assessment
           system." Similarly, the California LAO concluded that tax
           avoidance "by some taxpayers shifts the relative tax burden
           towards taxpayers already in compliance. This principle of
           fairness has ramifications for the tax system itself. A perception
           that the tax system is not equitable could result in noncompliance
           and tax avoidance by an increasing proportion of taxpayers."
		   
		   Precedent Exists for Changing the Statute for Offshore Examinations

           The Supreme Court found that statutes of limitations find their
           justification in necessity and convenience. According to a Supreme
           Court opinion, statutes of limitations are practical and pragmatic
           devices to spare the court from litigation of stale claims, and
           the citizen from being put to his defense after memories have
           faded, witnesses have died or disappeared, and evidence has been
           lost.^26 The opinion goes on to say that statutes of limitations
           are by definition arbitrary. Historically, the assessment statute
           of limitations has varied in length. For example, the Revenue Act
           of 1919^27 set the statute of limitations for tax assessments at 5
           years. The statute was changed to 2 years in 1932.^28 The current
           3-year statute stems from the Revenue Act of 1934.^29 As described
           above, Congress granted changes and exceptions to the statute over
           the years to address various types of enforcement problems. Given
           the similarities between the enforcement problems exhibited by
           offshore examinations and the enforcement problems giving rise to
           past changes and exceptions to the statute, precedent exists for
           changing the statute for offshore examinations.
		   
		   Changing the Statute Would Necessitate Weighing Advantages and
		   Disadvantages

           Changing the statute for offshore examinations would necessitate
           weighing advantages and disadvantages. If Congress wishes to
           change the statute for examinations where offshore compliance is
           the major issue, certain design options, such as limiting any
           examination and possible assessment to those issues attributable
           to offshore transactions or only suspending the statute while IRS
           is waiting for taxpayer responses to IRS data requests, might
           mitigate some of the disadvantages of the statute extension.
		   
		   Changing the Statute Would Necessitate Weighing Advantages and
		   Disadvantages

           Changing the statute for examinations in which offshore
           transactions are a major enforcement problem will require weighing
           both advantages and disadvantages. In addition to advantages, such
           as fairness or deterrence, mentioned earlier as justification for
           extending the statute for unreported listed transactions and ATS
           transactions, interested parties from various organizations that
           represent taxpayers or work with tax issues mentioned other
           advantages and disadvantages for an exception to the statute for
           offshore examinations. For example, they mentioned the ability of
           IRS to look back at several tax years once an offshore scheme is
           identified as an advantage of such an exception. On the other
           hand, they mentioned that such an exception would further
           complicate the tax code by adding another provision that would
           most likely include complicated criteria addressing offshore
           transactions. Table 7 summarizes their views on such an exception
           in general.

           Table 7: Views of Interested Parties in General on Changing the
           Statute for Offshore Examinations
		   
		   Advantages                         Disadvantages                           
      o Increases perceptions of         o Complicates tax laws by adding     
      fairness                           complex criteria                     
      o Enhances deterrent effect        o Creates another precedent for      
      o Allows IRS to look back at       future exceptions                    
      several tax years once a scheme    o Increases uncertainty and lack of  
      is identified                      closure                              
                                         o Increases recordkeeping costs      
                                         o Increases difficulty of            
                                         marshalling a defense as memories    
                                         fade and records disappear           
                                         o Duplicates tools already available 
                                         to IRS (e.g., fraud, consent         
                                         agreements, etc.)                    
                                         o Increases IRS focus on old         
                                         returns, which may not be a good use 
                                         of IRS resources                     
                                         o Increases perceptions of           
                                         unfairness unless matched by an      
                                         extended refund period               

           Source: GAO analysis of comments by interested parties from
           various organizations that represent taxpayers or that work with
           tax issues. These organizations included the American Association
           of Attorney--Certified Public Accountants, American Bar
           Association, American Institute of Certified Public Accountants,
           National Association of Enrolled Agents, National Association of
           Tax Professionals, National Society of Accountants, National
           Society of Tax Professionals, and the Department of the Treasury
           (IRS Small Business/Self Employed division, Taxpayer Advocate
           Service, IRS Office of Chief Counsel, and Department of the
           Treasury Office of Tax Policy).

           In commenting on an exception to the statute for offshore
           examinations, these interested parties also pointed out advantages
           and disadvantages for various design options that could be used to
           implement such an exception. These options relate to (1) the scope
           of an exception and (2) the way in which IRS is afforded
           additional time to address the enforcement problems presented by
           offshore examinations. Scope refers to (1) which taxpayers will be
           subject to the exception and (2) the extent to which the exception
           allows IRS to examine a tax return. The way in which IRS is
           afforded additional time refers to (1) an extension to the
           statute, such as for an additional 3 years from the filing date of
           a tax return or (2) a suspension of the statute pending resolution
           of a compliance problem, such as slow taxpayer response to IRS
           records requests. A suspension is triggered by a specified event
           or action. Table 8 presents the views of these interested parties
           on the advantages and disadvantages of these design options.

^15Chapter 277, 48 Stat. 683, May 10, 1934.

^16Chapter 463, 39 Stat. 756, Sept. 8, 1916.

^17Pub. L. No. 105-34, Aug. 5, 1997.

^18Listed transactions are the same as, or substantially similar to, a
transaction specifically identified by IRS as a tax avoidance transaction.
For a transaction to be a listed transaction, IRS must issue a notice,
regulation, or other form of published guidance informing taxpayers of the
details of the transaction. IRS listed 31 such transactions as of January
2007.

^19Pub. L. No. 108-357, Oct. 22, 2004.

^20Treas. Reg. Sec. 301.6112-1 and Treas. Reg. Sec. 1.6011-4.

^21Treasury Inspector General for Tax Administration, The Settlement
Initiative for Investors in a Variety of Bond and Option Sales Strategies
Was Successful and Surfaced Possible Next Steps for Curtailing Abusive Tax
Shelters, 2006-30-065 (Washington, D.C.: Mar. 31, 2006).

^22During 2005, the California FTB formed several new units to reduce the
tax gap. Among these new units was the Abusive Tax Shelter Unit, which was
formed to identify returns with abusive tax shelters and to foster
self-compliance. According to a California FTB manager, this unit
instituted a new approach to addressing potential participants in abusive
transactions. Based on disclosure information, investor lists, and tax
returns, she explained that the unit contacts taxpayers with a
self-compliance letter to solicit amended returns that reverse the
potentially abusive issues.

^23The California Tax Shelter Resolution Initiative provided analogous tax
treatment for California taxpayers participating in, or intending to
participate in, IRS's Settlement Initiative for an array of transactions,
including 16 listed transactions and 5 other transactions that IRS
considered potentially abusive. Taxpayers had until January 23, 2006, to
submit their settlement applications to IRS. To participate in the
California initiative, California taxpayers must have participated in the
IRS initiative. They had until March 31, 2006, to file an election to
participate in the California initiative. Both the IRS and California
initiative required payment of taxes owed and interest. Both also provided
penalty waivers and allowed transaction costs such as professional and
promoter fees.

^24House Report 108-548--Pt. 1 American Jobs Creation Act of 2004 (June
2004).

^25Senate Report 108-11--CARE Act of 2003 (Feb. 27, 2003).

^26Chase Securities Corp. v. Donaldson, 325 U.S. 304, May 21, 1945.

^27The Revenue Act of 1919, ch. 18, 40 Stat. 1057, February 24, 1919.

^28The Revenue Act of 1932, ch. 209, 47 Stat. 169, June 6, 1932.

^29The Revenue Act of 1934, ch. 277, 48 Stat. 683, May 10 1934.


Table 8: Views of Interested Parties on Design Options for Changing the
Statute for Offshore Examinations

Design option          Advantages                Disadvantages             
Exception applies to      o Increases simplicity    o Includes taxpayers   
all taxpayers having      when compared to a        having legitimate      
offshore                  case-by-case approach     reasons for offshore   
accounts/entities         o Increases certainty     accounts/entities      
                             when compared to a        o Requires clear       
                             case-by-case approach     criteria defining      
                                                       factors such as        
                                                       offshore account and   
                                                       offshore entity        
Exception applies on a    o Exempts taxpayers       o Requires clear       
case-by-case basis        having legitimate         criteria defining      
                             reasons for offshore      applicability          
                             accounts/entities         o Requires safeguards  
                                                       to prevent unwarranted 
                                                       application            
                                                       o Uncertainty for      
                                                       taxpayers as to        
                                                       whether they are       
                                                       covered                
Exception applies to      o Maximizes potential     o Expands examination  
entire tax return         for assessment            beyond offshore issues 
                                                       o Creates perceptions  
                                                       of unfairness          
Exception applies to      o Limits examination      o Requires safeguards  
offshore issues only      to offshore issues        to prevent scope       
                                                       expansion to           
                                                       nonoffshore issues     
Exception in the form     o Increases time to       o May ineffectively    
of a statute extension    identify participants     identify offshore      
                             o Increases time to       scheme participants    
                             develop examination       o Fails to guarantee   
                             o Increases time for      information needed for 
                             examination               assessment will be     
                                                       provided within the    
                                                       extended time          
Exception in the form     o Focuses on a            o Requires clear       
of a statute              specific problem          criteria for           
suspension                o Increases time to       triggering event       
                             address a specific        o Requires triggering  
                             problem                   event to occur before  
                                                       additional time        
                                                       allowed                

Source: GAO analysis of comments by interested parties from various
organizations that represent taxpayers or that work with tax issues. These
organizations included the American Association of Attorney--Certified
Public Accountants, American Bar Association, American Institute of
Certified Public Accountants, National Association of Enrolled Agents,
National Association of Tax Professionals, National Society of
Accountants, National Society of Tax Professionals, and the Department of
the Treasury (IRS Small Business/Self Employed division, Taxpayer Advocate
Service, IRS Office of Chief Counsel, and Department of the Treasury
Office of Tax Policy).

If Congress wishes to change the statute for examinations where offshore
compliance is a compliance problem, several of the design options
mentioned by interested parties might mitigate some of the disadvantages
of a statute exception for such examinations. To help clarify their
suggestions, we also developed some hypothetical examples to illustrate
their points. Specific suggestions that we heard included the following:

           o Making an exception apply to all taxpayers having offshore
           accounts/entities may mitigate concerns about taxpayer uncertainty
           and lack of closure.
           o Limiting any examination and possible assessment only to those
           issues attributable to offshore transactions might mitigate
           concerns about unfairly exposing taxpayers to open-ended IRS
           examinations or "fishing expeditions" that could result in
           assessments for issues unrelated to offshore transactions. For
           example, an examination triggered by a taxpayer possessing an
           offshore credit card could enable the IRS to examine depreciation
           expense for the plant and equipment used in the taxpayer's
           domestic business, which the taxpayer might perceive as unfair.
           o Suspending the statute until a specific issue is resolved, such
           as taxpayers not responding promptly to IRS requests for records,
           might mitigate concerns about an across-the-board extension of the
           3-year assessment period.
           o Specifying a length of time for an initial extension, such as 1
           year, and requiring a court or review board's approval for any
           subsequent extensions might also mitigate taxpayer concerns about
           potential IRS abuse of an exception to the statute for offshore
           examinations. This option might allay concerns about unwarranted
           application by IRS of a case-by-case exception to the statute.
           o Establishing a materiality test might mitigate concerns that IRS
           would focus on taxpayers having insignificant issues. This test
           could be, for example, (1) any amount greater than a percentage of
           a specific amount shown on a tax return such as 20 percent of
           total assets for taxpayers operating a business or (2) any amount
           greater than an absolute dollar amount such as any amount greater
           than $10,000. This option might allay concerns about including all
           taxpayers, particularly those having legitimate offshore
           transactions that are not substantial in value.
           o Limiting the exception to a case-by-case approach might mitigate
           concerns about taxpayers being unfairly subjected to an extended
           assessment period when they have legitimate offshore transactions.
           For example, an exception to the statute could be limited to
           taxpayers identified on client lists of known promoters of
           offshore schemes. This option might allay concerns about including
           all taxpayers, particularly those having legitimate reasons for
           offshore transactions.
           o Maintaining symmetry between the statute for assessments and the
           statute for refunds by matching any exception to the statute for
           assessments with the same exception to the statute for refunds
           might mitigate taxpayer concerns about the unfairness or
           one-sidedness of an exception to the statute for assessments. If
           the statute was suspended until taxpayers respond to IRS request
           for records, for example, the statute for refunds should also be
           suspended until the taxpayers respond to the request.
           o Assuring access to IRS appeals procedures and to the Tax Court
           might mitigate taxpayers' concerns about the potential for IRS
           abuse as well as provide due process should they decide to
           challenge IRS's use of such an exception to the statute. For
           example, procedures requiring TIGTA to investigate any taxpayer
           allegations of denial of due process could be mandated.
		   
		   Conclusions

           As with all forms of tax evasion, it is important that IRS pursue
           offshore tax evasion because it adds to the tax gap, increases the
           tax burden on honest taxpayers, and poses a threat to the
           integrity and fairness of our tax system by adversely affecting
           voluntary compliance when honest taxpayers come to believe that
           other people are getting away with not paying their fair share.
           Offshore tax evasion is special, though, in that the examinations
           that IRS pursues typically take much longer to develop and examine
           because of the inherent difficulty in identifying and obtaining
           information from foreign sources, the often dilatory and
           uncooperative tactics on the part of taxpayers and their
           representatives, and the technical complexity of the examinations.

           Nevertheless, the statute of limitations that applies to offshore
           examinations is the same as applies to all returns. This leads to
           some suspected tax evasion that IRS identifies going unexamined
           when revenue agents and managers choose not to start work on
           offshore examinations because there is too little time remaining
           under the statute or choose to cut work off early in order to
           avoid a barred statute. There are exceptions that permit IRS to
           continue examinations past the 3-year point and still make
           assessments, but in many offshore examinations IRS has only 3
           years to complete its work. Furthermore, taking an examination
           past the 3-year point in anticipation of finding fraud or one of
           the other exceptions permitted under the statute represents a
           gamble by IRS that the investment of additional examination
           resources will ultimately result in an assessment being allowed
           under the law.

           Past Congresses have recognized the need for statute exceptions in
           the face of similar compliance and enforcement obstacles. In the
           case of the statute exception for unreported listed transactions,
           Congress delegated to IRS the responsibility for defining the
           specific circumstances triggering the exception. A statute
           exception for offshore examinations that balances the additional
           layers of difficulty for IRS in detecting and examining offshore
           cases with fairness to taxpayers involved in legitimate offshore
           financial activity would strengthen IRS's efforts to combat
           offshore tax evasion. Additional time to complete examinations
           would give IRS greater flexibility in choosing which examinations
           to open and when to close them. This would likely lead to fewer
           examinations where revenue agents abandon the pursuit of apparent
           noncompliance simply because they are running out of time.
		   
		   Matter for Congressional Consideration

           In order to provide IRS with additional flexibility in combating
           offshore tax evasion schemes, Congress should make an exception to
           the 3-year civil statute of limitations assessment period for
           taxpayers involved in offshore financial activity. Similar to
           Congress's approach to unreported listed transactions, Congress
           may wish to establish a process wherein IRS would identify the
           types of offshore activity to which a statute exception would
           apply.
		   
		   Agency Comments and Our Evaluation

           We received e-mail and oral comments from IRS's SB/SE division and
           the IRS General Counsel's office about a draft of this report. The
           officials making comments noted that a longer statute for offshore
           examinations makes sense and should enhance compliance. They also
           discussed how the offshore-to-nonoffshore comparisons in the draft
           of this report were typically made for all types of examinations,
           rather than only of field examinations. They observed that field
           examinations are by far the most common type of examination used
           for offshore tax evasion cases and suggested that a comparison of
           just field examinations would also be useful to the reader. We
           agreed and we changed our discussion of offshore-to-nonoffshore
           examinations to include comparisons both of all types of
           examinations collectively and field examinations alone. Also in
           their comments, IRS officials clarified other technical and legal
           issues, which we incorporated in this report where appropriate.

           As agreed with your offices, unless you publicly announce its
           contents earlier, we plan no further distribution of this report
           until 30 days from its issue date. At that time, we will send
           copies to the Chairman and Ranking Member, House Committee on Ways
           and Means; the Secretary of the Treasury; the Commissioner of
           Internal Revenue; and other interested parties. Copies will be
           made available to others upon request. This 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, please contact me at
           (202) 512-9110 or [email protected]. Contact points for our Offices
           of Congressional Relations and Public Affairs may be found on the
           last page of this report. Key contributors to this report are
           listed in appendix II.

           Michael Brostek
		   Director, Tax Issues Strategic Issues Team		   
		   
		   Appendix I: Objectives, Scope, and Methodology

           The objectives of this report were to (1) compare the length of
           and recommended assessments yielded by offshore and nonoffshore
           examinations and determine the effect of the 3-year statute of
           limitations on recommended offshore assessments, (2) determine
           whether or not enforcement problems posed by offshore examinations
           are similar to those where Congress has previously granted an
           exception to the statute, and (3) identify possible advantages and
           disadvantages of an exception to the statute for offshore
           examinations.

           To compare the length of and recommended assessments yielded by
           offshore and non-offshore examination cases and determine the
           effect of the statute of limitations on offshore assessments, we
           examined the Internal Revenue Service (IRS) Audit Information
           Management System Reference (AIMS) database, which holds all IRS's
           data about completed examinations. The database included a variety
           of taxpayers, including individuals, businesses, and corporations,
           including large corporations. We analyzed fiscal years 2002
           through 2005, the most recent years for which IRS had data at the
           time of our evaluation. We grouped all examinations maintained in
           the AIMS database by whether they were offshore examinations (as
           determined by the project code under which all examinations are
           categorized) or not offshore examinations. We found that there
           were both offshore and nonoffshore examinations represented among
           all of the types of taxpayers in AIMS with the exception of excise
           tax examinations, which were only found in the nonoffshore subset.
           We used the AIMS data to analyze the number of days cases spent in
           both development and examination and the recommended assessments
           from both offshore and nonoffshore examinations. We further
           subdivided the data to compare only field examinations, because
           these were the most common type of offshore examination. To assess
           the reliability of the AIMS data, we reviewed AIMS documentation,
           and conducted electronic testing of key variables. Based on this
           work, we determined that the AIMS data were sufficiently reliable
           for our purposes.

           We spoke with 17 IRS revenue agents and managers with expertise in
           the offshore area about their experience in conducting and closing
           offshore examinations. We also examined 12 offshore examination
           case files to gain an understanding of the circumstances that IRS
           revenue agents face in dealing with noncompliant taxpayers. We
           spoke with IRS representatives to gain an understanding of how
           cases are identified for examination, and to determine the process
           by which an offshore case is developed and examined. In addition,
           we reviewed various IRS documents related to the statute of
           limitations on assessments, including exceptions to the statute.

           To determine whether or not enforcement problems posed by offshore
           cases are similar to those where Congress granted an exception to
           the statute in the past, we identified enforcement problems posed
           by offshore examinations. To do so, we examined IRS's AIMS
           database, examined case files and spoke with IRS representatives.
           We also identified enforcement problems where Congress granted an
           exception to the statute in the past. To do so, we researched the
           history of the federal statute of limitations for assessments. We
           also reviewed legislation proposed between 2003 and 2006 that
           included references to either offshore tax evasion or the statute
           of limitations. This included the American Jobs Creation Act of
           2006 and other legislative proposals related to the statute. In
           addition, we reviewed reports prepared by the Treasury Inspector
           General for Tax Administration and California state agencies
           related to tax avoidance issues and the statute. We supplemented
           these reviews with discussions with representatives of the
           California Franchise Tax Board.

           To identify advantages and disadvantages of granting an exception
           to the statute for offshore examinations, we interviewed
           representatives of various organizations to obtain views on
           mandating an exception to the statute for offshore examinations.
           Such an exception would afford IRS more time to develop and
           examine offshore examinations. These organizations included the
           American Association of Attorney--Certified Public Accountants,
           American Bar Association, American Institute of Certified Public
           Accountants, National Association of Enrolled Agents, National
           Association of Tax Professionals, National Society of Accountants,
           and National Society of Tax Professionals. We also interviewed
           representatives of various organizations within the Department of
           the Treasury to obtain their views. These organizations included
           the IRS Small Business/Self Employed division, the Taxpayer
           Advocate Service, the IRS Office of Chief Counsel, and the
           Department of the Treasury Office of Tax Policy.
		   
		   Appendix II: GAO Contact and Staff Acknowledgments
		   
		   GAO Contact

           Michael Brostek, (202) 512-9110 or [email protected]

           Acknowledgments

           In addition to the contact named above, David Lewis, Assistant
           Director; Perry Datwyler; Evan Gilman; Shirley Jones; John Mingus;
           and Jeff Schmerling made key contributions to this report.
		   
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(450367)

www.gao.gov/cgi-bin/getrpt?GAO-07-237 .

To view the full product, including the scope
and methodology, click on the link above.

For more information, contact Michael Brostek at (202) 512-9110 or
[email protected].

Highlights of [33]GAO-07-237 , a report to the Committee on Finance, U.S.
Senate

March 2007

TAX ADMINISTRATION

Additional Time Needed to Complete Offshore Tax Evasion Examinations

Much offshore financial activity is not illegal, but numerous illegal
offshore schemes have been devised to hide or disguise the true ownership
of income streams and assets. IRS studies show lengthy development times
for some offshore cases, which suggests that time or the lack thereof
could be an impediment to effectively addressing offshore schemes.

GAO was asked to (1) compare offshore and nonoffshore examination cases
and determine whether the 3-year statute of limitations reduces offshore
assessments, (2) compare enforcement problems posed by offshore cases to
those where Congress has previously granted an exception to the statute,
and (3) identify possible advantages and disadvantages of an exception to
the statute for offshore cases. To address these objectives, GAO analyzed
IRS data, reviewed examination files and other documents, and interviewed
IRS officials and others in the tax practitioner and policy communities.

[34]What GAO Recommends

To provide IRS with additional flexibility in combating offshore schemes,
Congress should consider a longer statute period for taxpayers involved in
offshore activity. In e-mailed comments on a draft of this report, IRS
expressed agreement that a longer statute makes sense and should enhance
compliance.

Examinations involving offshore tax evasion take much more time to develop
and complete than other examinations for reasons such as technical
complexity and the difficulty of obtaining information from foreign
sources. When examinations are completed, the resulting median assessment
from an offshore examination is almost three times larger than from other
types of examinations. However, due to the 3-year statute, the additional
time needed to complete an offshore examination means that IRS sometimes
has to prematurely end offshore examinations and sometimes chooses not to
open one at all, despite evidence of likely noncompliance. Although data
were not available to measure the effect of the statute on assessments,
IRS agents and managers told GAO that overall assessments for offshore
cases are lower than they would be if IRS had more time to work these
cases.

Median Assessment Amount by Number of Examination Days, Examinations
Closed with an Assessment, Fiscal Years 2002-2005

Some offshore examinations exhibit enforcement problems similar to those
where Congress has granted a statute change or exception in the past. For
example, Congress changed the statute for certain abusive tax shelters
that involved technical complexity and dilatory tactics on the part of
taxpayers.

Through discussions with IRS officials and others in the tax practitioner
and policy communities, GAO identified advantages and disadvantages to
such an exception. Advantages included increased flexibility for IRS to
direct enforcement resources to egregious cases of noncompliance and a
possible deterrent to future noncompliance. Disadvantages included
increased uncertainty and lack of closure for taxpayers. Our commenters
also discussed design options to mitigate some of the disadvantages of a
statute extension, such as making an exception apply to all taxpayers
having offshore accounts/entities, and thereby, mitigating taxpayer
uncertainty and lack of closure.

References

Visible links
  24. http://www.gao.gov/cgi-bin/getrpt?GAO-02-618T
  33. http://www.gao.gov/cgi-bin/getrpt?GAO-07-237
*** End of document. ***