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United States General Accounting Office: 
GAO: 

Testimony: 

Before the Committee on Finance, U.S. Senate: 

For Release on Delivery: 
Expected at 10:00 a.m. 
Thursday, April 11, 2002: 

Internal Revenue Service: 

Enhanced Efforts to Combat Abusive Tax Schemes—-Challenges Remain: 

Statement by Michael Brostek: 
Director, Tax Issues: 

GAO-02-618T: 

Mr. Chairman and members of the committee: 

I appreciate the opportunity to testify on the Internal Revenue 
Service’s (IRS) efforts to identify and deal with abusive tax schemes 
that primarily are used by individual taxpayers.[Footnote 1] My 
statement today, based on work we have done at the committee’s 
request, focuses on what is known about the extent of abusive tax 
schemes involving individual taxpayers, the status of IRS’s efforts to 
combat such schemes, and challenges IRS faces in moving forward. 

During hearings before this committee last April, several witnesses 
testified about the increased promotion and use of various types of 
abusive tax schemes and scams, including constitutional trusts, 
offshore trusts, and tax credits for slave descendants. Not all of 
these schemes were new, but in part due to the ease of marketing 
schemes cheaply through the Internet, schemes were flourishing. Use of 
such schemes can 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. Thus, IRS’s efforts to 
pursue abusive tax schemes are key to ensuring that such schemes do 
not undermine the federal tax system. 

My statement today will make the following points: 

* Estimating the extent of abusive tax schemes used by individual 
taxpayers is at best an inexact process because these schemes are 
often hidden. Nevertheless, IRS officials believe that the number and 
dollar consequence of schemes has grown in recent years. As of 
February 2002, IRS estimated that in tax year 2000 about 740,000 
taxpayers had used abusive schemes. IRS caught about $5 billion in 
improper tax avoidance or tax credit and refund claims, but estimated 
that another $20 billion to $40 billion had not been identified and 
addressed. Recent developments suggest that the number of individuals 
involved in one type of abusive tax scheme involving offshore accounts 
may be greater than what IRS estimated just 2 months ago, and thus, 
potential lost revenues may be higher. 

* In part because no one individual or office could provide an 
agencywide perspective on IRS’s strategy, goals, objectives, 
performance measures, or program results, it is difficult to provide a 
clear picture of all that is underway and being accomplished in IRS’s 
efforts to address abusive tax schemes. Available information 
suggests, however, that IRS has created new offices, reemphasized and 
reorganized certain prior efforts, and planned to assign or already 
assigned at least 200 additional staff to its efforts. Limited data 
also suggest that IRS’s enhanced focus has led to some increased 
success in convicting those promoting and taking advantage of abusive 
schemes, in publicizing these results, and in uncovering previously 
hidden major offshore compliance problems. 

* The sheer number of possible abusive tax schemes that likely will 
require face-to-face audits could outstrip IRS’s available resources. 
Furthermore, identifying and handling these cases will require a 
better-coordinated effort on IRS’s part. IRS has recognized these 
challenges and is beginning to work on solutions and options. To date, 
however, IRS has not developed a means to track the resources, in 
particular staffing, devoted to combating abusive schemes or developed 
goals and measures that Congress and IRS can use to assess its 
progress. 

Background: 

According to IRS, during the mid to late 1990’s, abusive tax schemes 
reemerged across the country. The use of abusive tax shelters, anti-
taxation arguments, abusive tax schemes, and frivolous returns last 
peaked in the 1980’s. IRS characterizes an abusive tax scheme as any 
plan or arrangement created and used to obtain tax benefits not 
allowable by law. Schemes run from simple to very complex, from 
clearly illegal to those carefully constructed to disguise the 
illegality of the scheme. Furthermore, users of schemes can range from 
those believing their position is correct to those who knowingly but 
willfully file incorrect tax returns. Schemes can be based on improper 
use of domestic and foreign trusts, inflated business expenses and 
deductions, falsely claimed tax credits and refunds, and various anti-
tax arguments. Some schemes are created by tax professionals such as 
accountants, lawyers, and paid tax preparers, or by groups and 
individuals. Tax schemes are offered to taxpayers using various means, 
including conferences or seminars, publications, advertisements, and 
the Internet. Others are promoted by word-of-mouth. 

Abusive tax schemes that are generally used by individuals fall into 
four major categories. For the first two of these, frivolous returns 
and frivolous refunds, taxpayers submit a tax return that either 
states an argument that IRS can readily identify as frivolous, or a 
return with characteristics IRS has identified as reflecting a 
frivolous argument. For the other two types of schemes, abusive trusts 
and offshore compliance strategies, taxpayers’ returns are less likely 
to reveal use of a clearly abusive tax scheme. 

Frivolous Returns: 

These schemes generally use any number of anti-tax arguments to 
incorrectly claim that income is exempt from taxation or that IRS 
otherwise lacks authority needed to tax income. These arguments have 
been well litigated in the courts and consistently ruled to be without 
merit. Examples include the following: 

* Form 2555 Scheme: In this scheme, individuals file an IRS Form 2555, 
Foreign Earned Income, and claim that their income was not earned 
within the United States. This is also known as the “not a citizen” 
argument in which taxpayers file returns stating they are citizens of 
the “Republic of [any state]” and not citizens of the United States, 
and thus, their income is not taxable. 

* Section 861: Individuals using this scheme claim that under Internal 
Revenue Code section 861 income tax must only be paid on foreign 
income and, therefore, their income is not subject to tax or 
withholding. In these cases, taxpayers file a tax return and show a 
zero amount for wages. According to IRS, this argument has spread to 
some employers who are using it to avoid withholding and paying 
payroll-type taxes on their employees. 

Frivolous Refunds: 

According to IRS, credit and refund abusive tax schemes are designed 
to substantially reduce taxes or create a refund for the taxpayer, 
generally by claiming eligibility for a credit that does not exist or 
to which the taxpayer is not properly entitled. One such scheme that 
has received much attention is the Slavery Reparation Refund scheme. 
According to IRS, promoters circulate or publish information claiming 
African Americans are eligible for slavery reparations. Taxpayers 
claiming this credit generally enter a significant amount on their tax 
return as a credit that results in a taxpayer realizing a refund if 
not detected by IRS. 

Abusive Domestic Trusts: 

A trust is a legitimate form of ownership, which completely separates 
asset responsibility and control from the benefits of ownership. As 
such, trusts are commonly used in matters such as estate planning. An 
abusive domestic trust scheme usually involves a taxpayer creating a 
trust that does not meet the Internal Revenue Code requirements that 
the assets and income of the trust not be subject to the control of 
the taxpayer. Once such an improper trust is established and the 
taxpayer has transferred business or personal assets to it, the scheme 
may involve further abuses, such as offsetting income of the trust by 
overstating its business expenses or including the taxpayer’s personal 
expenses—-like a home mortgage—-as an expense of the trust. The 
taxpayer will often use multiple entities such as partnerships, 
limited liability companies, or secondary level trusts that can be 
tiered or layered to mask the taxpayer’s continued ownership or 
control of the trust’s income or assets. 

Offshore Schemes: 

Abuses that involve foreign locations can take a wide array of forms 
and attempt to use a number of techniques to improperly avoid paying 
taxes. One common technique is simply to use foreign locations to add 
another level of complexity in obscuring the true ownership of assets 
or income and thus obfuscating whether taxes are owed and by whom. Use 
of foreign locations, for instance, can be combined with use of trusts 
to make unraveling the true ownership of assets and income more 
difficult for IRS. According to IRS, criminals long have used offshore 
schemes to disguise the true nature of their enterprise and the 
resulting income. Promoters of abusive tax schemes have, according to 
IRS, increasingly devised schemes that in some fashion involve 
transferring income or title to assets to foreign locations. Often 
foreign locations are selected because they are tax havens with little 
or no taxation on income in their jurisdiction, have privacy rules 
that help schemers hide what they are doing, or have other 
characteristics favorable to carrying out the schemes. According to 
IRS, once such transfers are established, income is often repatriated 
back to the U.S. owners through loans, credit cards, or debit cards. 
By using complex transactions and multiple entities, the individuals 
using these schemes attempt to hide their income and avoid potential 
tax liabilities. 

Evidence of Rapid Tax Scheme Growth: 

According to IRS’s fiscal year 2003-2004 Small Business and Self-
Employed (SB/SE) Division Strategic Assessment Report,[Footnote 2] 
abusive tax schemes represent a rapidly growing risk to the tax base. 
IRS estimates the potential revenue loss from these schemes to be in 
the tens of billions of dollars annually. According to an IRS 
official, to make accurate estimates in this area of noncompliance is 
difficult. For one reason, the nuances and types of schemes are 
constantly changing and evolving, particularly in the areas of abusive 
trusts and offshore compliance. Also, IRS’s detection of schemes is 
challenging. Trust schemes, in particular, often involve multiple 
entities that are vertically layered or tiered in an attempt to 
disguise the true ownership of the income or assets of the trust. The 
difficulty in determining the significance of offshore compliance is 
also exacerbated because these types of schemes generally use tax 
haven countries to disguise the transactions and prevent IRS from 
routinely collecting tax-related information on transactions. 

Despite the difficulties in accurately estimating the significance of 
abusive tax schemes, IRS provided us with estimates in four major 
scheme areas—-Frivolous Returns, Frivolous Refunds, Abusive Domestic 
Trusts, and Offshore Schemes. According to IRS, its estimates were 
made in February of 2002 and were derived from information gathered 
during tax return processing and examination activities and from the 
work of IRS’s Criminal Investigation, the law enforcement arm of IRS. 
According to an IRS official, these estimates were derived from tax 
year 2000 information, the last full year for which data were 
available. IRS’s estimates are as follows: 

* Frivolous returns: about 62,000 taxpayers with associated tax 
amounts approximating $1.8 billion. 

* Frivolous refunds: about 105,000 taxpayers with associated tax 
amounts approximating $3.1 billion. 

* Abusive domestic trusts: about 65,000 taxpayers with tax losses 
approximating $2.9 billion. 

* Offshore schemes: about 505,000 taxpayers with tax losses ranging 
from $20 billion to $40 billion. 

IRS’s estimates for the numbers of taxpayers and taxes in connection 
with frivolous returns and refunds, although not precise, likely have 
less uncertainty than its estimates of the numbers of taxpayers and 
taxes at risk in connection with abusive domestic trusts and offshore 
schemes. IRS’s estimates for frivolous returns and refunds are based 
in large part on returns and refund claims that IRS has identified 
while processing tax returns and has addressed by pulling the 
associated returns and notifying the taxpayers that their returns 
contained errors that need to be corrected. 

Thus, in these cases, IRS has a fairly direct basis for counting the 
number of taxpayers involved and the amount of tax involved. 
Furthermore, because IRS has pulled these returns from processing, in 
general, improper refund claims have not been paid out, and IRS is 
pursuing collection of the proper amount of tax when taxpayers have 
failed to pay the full amount owed.[Footnote 3] 

In contrast, although taxpayers using domestic trusts and offshore 
schemes may file tax returns, those returns alone seldom provide 
enough information for IRS to determine whether an abusive scheme was 
used. Therefore, IRS’s estimates of the numbers of taxpayers and the 
taxes at risk for the domestic trust and offshore scheme categories 
generally rely on limited numbers of cases that have been examined or 
investigated, on intelligence obtained in the course of normal tax 
administration and Criminal Investigation activities, and on IRS 
officials’ professional judgments. 

Recognizing that offshore transactions are a significant factor in 
offshore schemes, IRS has been taking steps concerning the use of 
credit/debit cards issued by offshore banks to U.S. taxpayers. 
Although having an offshore credit card is not illegal, IRS believes 
that some U.S. taxpayers are using such cards to evade U.S. taxes. In 
October 2000, a federal judge authorized IRS to serve “John Doe” 
summonses on American Express and MasterCard to obtain limited 
information on U.S. taxpayers holding credit cards issued by banks in 
several tax haven countries. 

On the basis of information received from MasterCard, IRS identified 
about 235,000 accounts issued through 28 banks located in 3 countries. 
IRS’s ongoing analysis of these data leads it to estimate that between 
60,000 and 130,000 U.S. customers are associated with these 235,000 
accounts. In part because MasterCard is estimated to have about 30 
percent of this market, IRS estimates that there could be 1 to 2 
million U.S. citizens with credit/debit cards issued by offshore 
banks. However, this is a very preliminary estimate. IRS officials 
believe this estimate may be reduced because, among other things, a 
portion of these accounts may not be associated with abusive tax 
schemes. By comparison, only about 117,000 individual taxpayers 
indicated that they had offshore bank accounts in tax year 1999. On 
March 25, 2002, IRS petitioned for permission to serve a summons on 
VISA International, seeking records on transactions using cards issued 
by banks in over 20 tax-haven countries. 

The estimates of the number of individuals and dollar consequences 
associated with offshore credit/debit card schemes are very uncertain 
at this time. Nevertheless, IRS’s February 2002 estimate of $20 
billion to $40 billion in tax dollars at risk from offshore schemes 
may grow as IRS learns more about the extent of the problem. 

Expanded IRS Efforts to Identify and Control Tax Schemes" 

No one individual or office could provide an agencywide perspective on 
IRS’s strategy, goals, objectives, performance measures, or program 
results, for its efforts to address abusive tax schemes. Consequently, 
a clear and consistent picture of IRS’s efforts was difficult to 
obtain. Available information indicates that IRS began increasing its 
efforts to combat abusive schemes over the past 2 or 3 years, 
continued to do so in 2001, and plans further future efforts. Limited 
data also suggest that these enhanced efforts have helped IRS convict 
more promoters and users of abusive schemes over the past 3 years, 
which IRS has publicized through enhanced communication strategies. 

Organizationally, IRS identifies and deals with schemes in two primary 
ways—-during its processing and examination of tax returns (compliance 
and enforcement) and through the work of Criminal Investigation (CI). 
However, most of IRS’s programs to address abusive schemes are the 
responsibility of SB/SE and CI. IRS also works with various federal 
agencies in its efforts to identify and deal with abusive tax schemes. 

Compliance and Enforcement Efforts: 

IRS has taken a number of steps to enhance its compliance and 
enforcement efforts—its audit and other civil enforcement activities—
that focus on abusive tax schemes. In the past year, for example, IRS 
has increased staff years devoted to examining abusive tax scheme 
promoters, decided to assign about 50 more agents to promoter 
examinations and train them, and laid plans for assigning 200 or more 
additional staff to reviewing abusive tax schemes and offshore 
compliance schemes. Furthermore, IRS has created an organization that 
initially will focus on developing leads and cases related to abusive 
scheme promoters and that will monitor promoter web sites. 

IRS identifies many abusive tax schemes during its normal tax return 
processing and examination activities. For example, when tax returns 
initially are processed either manually or by computers, processes are 
in place to detect apparent frivolous returns or returns reflecting 
improper refunds. In these cases, the returns are pulled from 
processing to be forwarded elsewhere for follow-up action. Both the 
Wage and Investment (W&I) and SB/SE divisions in IRS process taxpayers’
 tax returns and both have responsibilities for identifying tax 
returns that may involve abusive tax schemes. 

Three principal SB/SE efforts focusing on or related to abusive tax 
schemes are: 

* the Frivolous Return Program, 

* the Office of Flow-Through Entities and Abusive Tax Schemes, and; 

* the National Fraud Program. 

Frivolous Return Program: 

The Frivolous Return Program identifies the tax returns of individuals 
who assert unfounded legal or constitutional arguments and refuse to 
pay their taxes or to file a proper tax return. The program also 
identifies returns claiming frivolous refunds, such as those involving 
slavery reparations. Generally, IRS provides guidance to those who 
process tax returns to identify the characteristics of returns 
claiming such frivolous arguments or refunds. IRS also has programmed 
its computers to do so. The Treasury Inspector General for Tax 
Administration helped IRS develop software programs to identify 
slavery reparation schemes. Since both W&I and SB/SE staff process tax 
returns, both divisions are involved in identifying such returns. 

Once identified, the returns are pulled out of the tax return 
processing stream and forwarded to the Frivolous Return Program unit 
where they are to be resolved with the taxpayer. The program was 
consolidated in January 2001, at the Ogden, Utah, Compliance Services 
Center. The compliance center staff enters information about each case 
into a database and assigns 1 of 31 different codes identifying the 
frivolous argument or refund being claimed by the taxpayer. Then, a 
notice requesting taxpayers to file a proper tax return is to be sent 
advising them that IRS has judged their tax return to include an 
argument that is without legal merit or a credit or tax refund to 
which they are not entitled. 

IRS officials indicate that the number of staff assigned to the 
Frivolous Return Program unit in Ogden grew from 18 employees in 
September 2000 to 45 employees in September 2001. Some of this 
increase may not reflect a net IRS-wide increase in full-time 
equivalents (FTE) for frivolous returns since the increase has, in 
part, been due to centralizing efforts in Ogden from other IRS 
locations. IRS officials expect to assign more employees to this 
program in fiscal year 2003. 

Office of Flow-Through Entities and Abusive Tax Schemes: 

The Office of Flow-Through Entities and Abusive Tax Schemes became 
operational in January 2000.[Footnote 4] The office was created to 
organize IRS’s efforts in addressing abusive tax schemes, particularly 
trusts, and to identify their promoters and sellers. The unit’s goals 
are (1) to catalog and profile schemes and trends, (2) direct 
compliance resources to examine schemes and promoters or refer tax 
scheme promoters and participants for criminal prosecution, (3) 
increase employee knowledge and skills related to abusive tax scheme 
issues, and (4) enhance coordination within IRS on issues related to 
abusive tax schemes. 

IRS expects to assign and train about 50 revenue agents this fiscal 
year to focus mainly on promoters of abusive tax schemes. The agents 
are to undergo training during the summer of 2002 and to begin 
examining cases by the fall of 2002. According to IRS, the number of 
abusive promoter leads increased from 25 in March 2001 to 155 in 
February 2002. In addition, the number of abusive promoter cases 
approved for further examinations has increased from 17 cases to 94 
cases during the same period. The time spent on these cases is also 
increasing. IRS also reports that time spent on promoter examinations 
for fiscal year 2002 is expected to be 12.1 staff years, which is up 
from 4.4 and 1.2 staff years in fiscal 2001 and fiscal year 2000, 
respectively. 

Furthermore, IRS plans additional expansion of its abusive tax scheme 
compliance efforts. For example, IRS expects to develop units that 
will include 8 to 10 agents in each of 15 locations. These units will 
address abusive tax schemes and flow-through entities. In addition, 
given the growing significance of the offshore credit/debit card 
schemes, IRS plans to create four special enforcement groups. Each 
group will be staffed by approximately 8 agents and will concentrate 
on these offshore schemes. This growth in staffing reflects IRS’s 
increased priority for these schemes. IRS officials expect that the 
agents assigned to these units will be redirected largely from other 
compliance areas. 

Schedule K-1 Transcription and Matching. In the spring of 2001, the 
transcription of Schedule K-1 information became a major 
responsibility of the Office of Flow-Through Entities and Abusive Tax 
Schemes.[Footnote 5] According to IRS, information provided on 
Schedule K-1s is important for determining whether recipients of flow-
through income have properly reported that income on their tax 
returns. IRS can use transcribed data for information-matching to 
determine whether proper reporting of income occurred. 

IRS believes that flow-through entities such as trusts and 
partnerships are increasingly being used in abusive tax schemes. IRS 
can also use these K-1 data in its return examination and tax 
collection activities to help identify abusive tax schemes. 

Tax year 1995 marked the last year that Schedule K-1 information was 
transcribed by IRS. From 1990 through 1995, IRS transcribed 
approximately 5 percent to 12 percent of the Schedule K-1s received. 
After 1995, IRS did not transcribe Schedule K-1 information submitted 
with paper returns nor did it match the income information contained 
on the schedules with the information presented on individual 
beneficiaries’ or partners’ tax returns. IRS again started to 
transcribe tax year 2000 K-1 information during the spring of 2001 and 
completed the process in December 2001. IRS officials told us that the 
matching of the K-1 information against individual tax returns was to 
begin in March 2002. 

IRS cites several reasons for reinstating its transcription and 
matching of Schedule K-1s. First, IRS has observed a significant 
increase in flow-through entities. The number of tax returns filed by 
Trusts, Partnerships, and S-Corporations has increased by 12 percent, 
33 percent, and 35 percent, respectively, over the 6-year period from 
fiscal years 1995 through 2000. IRS also estimates an overall increase 
of nearly 2 million such returns by 2009. Second, based on a small 
study, in January 2002, IRS estimated that between 6 percent and 15 
percent of total flow-through income would not be reported on tax year 
2001 returns. Although data available to us at the time of this 
testimony were not clear, IRS estimates that income of about $1 
trillion was distributed to taxpayers from flow-through entities for 
tax year 2000. Third, IRS expects its Schedule K-1 matching program 
not only to identify underreporting or nonreporting of income but also 
to improve taxpayer compliance. Transcription and matching of Schedule 
K-1 data are expected to increase accurate reporting of trust income 
on future tax returns just as matching of wage, interest, and other 
types of income has increased the accuracy of taxpayers’ tax returns. 
As a result, the Schedule K-1 program places taxpayers who receive 
flow-through income on a more equal footing with taxpayers who are 
wage earners. 

Lead Development Center. IRS has adopted a strategy of identifying 
promoters of tax schemes as a key to halting their promotion and 
identifying those who have taken advantage of the scheme and thus 
likely owe taxes. By early April 2002, SB/SE is to initiate a Lead 
Development Center. The center’s primary functions are to develop case 
leads and assemble case information for distribution to compliance 
field offices for further investigation. Initially the center will 
focus on abusive tax scheme promoters, and over time, it will expand 
to perform similar functions for fraud and anti-money laundering 
cases. Also, the center will operate a computer laboratory that, among 
other things, is expected to monitor possible abusive promoter sites 
on the Internet. In addition, the center is to serve as a coordinating 
link among various IRS groups that deal with abusive tax scheme issues 
and with outside stakeholders such as the Department of Justice, the 
Federal Trade Commission (FTC), and others. 

National Fraud Program: 

The National Fraud Program, which operates at IRS’s campuses and field 
offices, coordinates efforts and provides oversight to IRS’s 
compliance efforts to identify potential tax fraud. In addition, the 
program helps identify trends and disseminates the information within 
IRS and acts as a liaison on fraud cases involving bankruptcy and 
employment and excise taxes among other types of tax fraud. A National 
Fraud Program manager sets overall policy and program direction. Fraud 
managers are located in five area offices, and they oversee the 
activities of about 65 fraud referral specialists. These specialists 
assist other IRS revenue compliance staff in identifying cases with 
fraud potential, determining when indications of fraud are present, 
and developing potential cases. They also review fraud cases for 
technical accuracy and adequacy of supporting documentation to ensure 
appropriate and consistent application of fraud program guidelines and 
requirements. In cases where there is evidence of criminal activity, 
those cases are to be referred to criminal investigation within IRS. 

Criminal Investigation IRS’s Criminal Investigation investigates and 
pursues promoters and sellers of abusive schemes and the individuals 
using such schemes. CI’s role is the enforcement of the tax laws for 
individuals who willfully fail to comply with their obligation to file 
and pay taxes and who ignore IRS’s collection and compliance efforts. 
The most flagrant cases are recommended for criminal prosecution. 

Criminal Investigation also administers the Questionable Refund 
Program that focuses on stopping the payment of various false tax 
refunds and, if warranted, on prosecuting the taxpayers involved. 
Furthermore, CI develops education and publicity activities warning 
taxpayers about abusive tax schemes and placed public information 
officers (PIO) in the field to specifically generate publicity 
regarding IRS’s law enforcement efforts. 

CI Enforcement Strategy: 

CI’s enforcement strategy as it relates to fraudulent tax schemes is 
to focus primarily on the promoters of these schemes and on taxpayers 
who willfully use these schemes to evade taxes. For example, during a 
tax scheme investigation, CI generally attempts to gain access to a 
fraudulent promoter’s list of clients to whom the promoter sold the 
scheme. In addition to pursuing the promoter, CI can then use the list 
of clients to determine who may have used the abusive scheme. CI 
determines which users of the abusive scheme merit investigation for 
possible prosecution and which users merit referral to IRS operating 
divisions for possible compliance and civil enforcement action. 

Although CI has data on enforcement activity related to several types 
of tax scams (e.g., related to employment tax, refunds, return 
preparers, nonfilers, and domestic and foreign trusts), CI only 
separately tracked its promoter efforts for domestic and foreign 
trusts. (See table 1.) CI officials said that the number of full-time 
equivalent staff working on domestic and foreign trusts increased from 
55 in fiscal year 1999 to 69 in fiscal year 2001. 

Table 1: Summary of Domestic and Foreign Trust Cases from Fiscal Year 
1999 through Fiscal Year 2001: 

Cases: Indictments; 
FY 1999: 35; 
FY 2000: 53; 
FY 2001: 32. 

(Promoters): 
FY 1999: 13; 
FY 2000: 14; 
FY 2001: 15. 

Cases: Convictions; 
FY 1999: 24; 
FY 2000: 31; 
FY 2001: 45. 

(Promoters): 
FY 1999: 3; 
FY 2000: 9; 
FY 2001: 23. 

Cases: Active Investigations; 
FY 1999: 131; 
FY 2000: 126; 
FY 2001: 165. 

(Promoters):
FY 1999: 49; 
FY 2000: 54; 
FY 2001: 66. 

Cases: Prosecutions Recommended; 
FY 1999: 57; 
FY 2000: 44; 
FY 2001: 30. 

(Promoters): 
FY 1999: 18; 
FY 2000: 14; 
FY 2001: 13. 

Note: Statistics in this table refer to individuals, such as 
indictments brought against 35 individuals in FY 1999. 

Source: IRS Criminal Investigation. 

[End of table] 

Although no consistent pattern exists across all of the categories in 
table 1, CI has had increases in the number of convictions obtained 
over the 3year period. Furthermore, looking only at promoter-related 
cases, indictments, convictions, and active investigations increased 
over the period while the number of prosecutions recommended declined. 
For purposes of deterring individuals from engaging in abusive trusts, 
the pattern of increasing convictions has provided IRS an opportunity 
to publicize more cases in which individuals have been found guilty. 
Further, the increases in indictments and convictions of promoters may 
help deter promoter activity in particular. 

Because the investigative and legal processes can span several years, 
data like those in the table do not show whether the cases 
investigated lead to prosecutions, convictions, and indictments in 
that same year. Further, the data do not account for differences in 
the importance of cases, such as whether major fraudulent efforts are 
being successfully investigated and closed. IRS data do show that the 
average length of sentence for the abusive domestic and foreign trust 
program rose substantially from 35 months in 1999 to 64 months in 
2001. To the extent that average length of sentence relates to the 
severity of the crime, IRS may be making headway in pursuing key 
abusive trust cases. 

Questionable Refund Program: 

The Questionable Refund Program (QRP), administered by CI, was 
established in 1977. The QRP was designed to identify false returns, 
stop the payment of false refunds, and prosecute scheme perpetrators. 
Various false refund schemes are pursued under this program, including 
ones involving the earned income tax credit, the fuel tax credit, 
social security refund schemes, and slavery reparations. Tax returns 
and return information are subject to manual processing or 
computerized information matching. IRS’s compliance staff identifies 
those returns claiming a possible false refund generally during these 
various return examination processes and referred to Questionable 
Refund Detection Teams (QRDT). The QRDT staff within CI determines 
which returns should be pursued within CI or civilly. Schemes with 
criminal potential are referred to CI field offices for investigation 
while schemes lacking criminal potential are referred to the 
appropriate IRS compliance or collection group. 

CI’s Education and Publicity Efforts: 

CI’s efforts to inform and educate the public about abusive tax 
schemes and to publicize the results of its enforcement activities 
related to such schemes take many forms and involve several types of 
media. CI has been particularly active in trying to disseminate 
information to the public to make them aware of IRS’s activities and 
accomplishments in combating abusive tax schemes.[Footnote 6] In 
addition, CI has PIOs located across the country who work with local 
media to publicize IRS’s efforts and results. 

CI Education and Publicity Activities. CI’s education and publicity 
activities focus on warning taxpayers about fraudulent tax schemes so 
that they will not be tempted to use such schemes. CI hopes that 
increasing media coverage of successful tax scheme prosecutions will 
deter the public from participating in tax schemes because the 
perceived risk of detection, prosecution, and resulting penalties and 
sanctions will be too high. In addition, CI officials believe that 
publicizing the prosecutions of promoters and users of tax schemes 
helps assure the public that people are paying their fair share of 
taxes. 

CI posted its web page [hyperlink, http://www.ustreas.gov/irs/ci] on 
the Internet in September 1997. According to CI officials, over the 
past 2 years the Internet site has evolved into an important tool for 
educating and alerting the public about tax schemes and about CI’s 
efforts to detect and deal with those who promote and use tax schemes. 
The Internet site provides: 

* fraud alerts warning the public of schemes where promoters are 
targeting unsuspecting taxpayers; 

* information on topics including tax filing responsibilities, 
nonfilers, and abusive tax return preparers; 

* summaries of cases and successful prosecutions of promoters and 
users of fraudulent schemes; and; 

* press releases and other IRS publications to generate a wide public 
distribution. 

Tax practitioners are also targets of CI’s publicity strategy. 
According to CI officials, some tax practitioners are using IRS’s 
materials directly from the Internet site to inform those clients who 
may believe that a given tax scheme is legal. For example, clients may 
ask the tax practitioner to set up a fraudulent trust to reduce their 
taxes, and the tax practitioner can simply print the brochure about “
Too Good to be True? – Trusts” from CI’s Internet site to discourage 
the taxpayers from using such a trust. 

In conjunction with using the Internet site as an informational tool 
to educate and warn the public of frivolous schemes, CI has taken 
steps to increase IRS’s visibility and presence on the Internet. 
According to CI, it has recently intensified its efforts to improve 
the ranking of IRS’s web page through the use of “metatags” or keyword 
tags. By doing so, IRS seeks to have Internet users who enter various 
terms in available Internet search engines find IRS’s web page listed 
near the top of displayed search results. For example, CI is planning 
to add tags such as “pay no tax,” and “form 1040” so that entering 
these terms will result in CI’s Internet site being listed in the 
displayed search results. 

CI is pursuing other possible strategies to ensure that CI’s site 
rises to the top of Internet search responses. For example, CI staff 
has occasionally visited known promoter Internet sites to gather 
information on keywords used by those sites. IRS plans to incorporate 
those keyword tags into its Internet site. As a result, IRS expects to 
increase the odds that the CI Internet site would be included 
alongside Internet sites that promote questionable tax avoidance 
strategies. In addition, CI is working to create a web content manager 
position with responsibilities that include designing a strategy to 
maximize the potential of CI’s Internet site. The manager would be 
responsible for helping to integrate CI data into the pages in IRS’s 
Internet site that provide information to specific types of taxpayers. 

CI Public Information Officers. In October 2000, CI established PIOs 
in each of IRS’s 35 field offices. The PIOs serve as points of contact 
for all internal and external CI communications initiatives, including 
the issuing of press releases and the coordination of important law 
enforcement media events. Although IRS has other media relations 
specialists located in its field offices, their duties tend to focus 
on publicizing tax filing season information, including the benefits 
of electronic filing. CI PIOs generate publicity regarding IRS’s law 
enforcement activities including the detection and prosecution of 
abusive tax schemes. 

Primary functions of the PIOs include: 

* establishing contacts with editors, reporters, and news directors to 
educate them on tax issues and provide information about IRS and CI to 
enable them to write in-depth articles. 

* encouraging media to include more stories on the detection and 
prosecution of abusive tax schemes. 

* getting articles included in trade and professional journals and 
magazines that are read frequently by professionals such as doctors, 
lawyers, and accountants to make them aware of abusive tax schemes. 

* developing a local media strategy. Part of CI’s local strategy 
involves generating a “hook” to get the stories focused more on 
communities. In addition, CI has employed a strategy of “bundling” 
news stories. For example, CI has been working cases on fraud involved 
in the restaurant industry. Once several such cases have been put 
together, CI will bundle these stories together into a single news 
story for possible publication in magazines and journals read by 
people in the restaurant industry. 

* giving speeches and participating in a wide variety of 
presentations, panel discussions, and conferences with professional 
organizations, including the American Bar Association, the American 
Institute of Certified Public Accountants, and the American Medical 
Association, to create public awareness of CI’s activities and to 
provide information about fraudulent tax schemes. 

IRS Coordination Efforts: 

IRS works with various federal agencies in its efforts to identify and 
deal with fraudulent tax schemes. These include the Federal Trade 
Commission (FTC),the Securities and Exchange Commission (SEC), the 
Financial Crimes Enforcement Network (FinCen), the Department of 
Justice (DOJ), the Federal Bureau of Investigation (FBI), and the 
United States Attorneys Offices (USAO). 

In some cases, IRS’s coordination is on an informal basis, as it is 
with the FTC and the SEC, and involves the sharing of certain 
information and detection techniques. In other cases, the relationship 
is more formal, as in the case with DOJ or USAOs, which prosecute 
fraud and other tax-related cases with the assistance of IRS staff. 

IRS officials participate in various federal agency working groups, 
including a multiagency task force to share information, skills, and 
procedures for combating fraud on the Internet; an IRS and DOJ working 
group created to examine the use of civil injunctions against abusive 
promoters currently under criminal investigation; and a money-
laundering experts working group. According to the officials we 
interviewed, these working groups are invaluable for developing 
networking relationships between agencies which facilitate information-
sharing among staff. 

IRS staff also attends quarterly meetings with staff from the FTC, 
SEC, and DOJ to develop joint initiatives to combat Internet fraud. 
These meetings have spawned other activities for IRS staff, including 
FTC-sponsored training seminars and periodic visits to FTC’s Internet 
laboratory to keep current with FTC efforts to combat Internet fraud. 

IRS Faces Substantial Challenges; Lacks Means to Assess Progress: 

IRS has tried to develop a better understanding of the potential 
breadth of the problem of abusive tax schemes involving individual 
taxpayers and the steps needed to coordinate and manage numerous 
efforts to combat abusive tax schemes. In some cases, these steps have 
been recently implemented, and in other cases, IRS is working to 
implement them. These expanded efforts have not been accompanied, 
however, by performance goals or measures that Congress and IRS can 
use to assess IRS’s progress. 

The increased scope of the abusive tax scheme problem, and perhaps 
especially the offshore compliance schemes, could strain IRS’s audit 
resources. IRS is now beginning to gather data that will better enable 
it to estimate the magnitude and nature of the offshore credit and 
debit card schemes. Improved data will help IRS identify how many and 
what types of resources it may need to address the schemes. However, 
the evasive nature of these schemes may necessitate face-to-face 
audits in a significant portion of cases to determine whether taxes 
are owed and the amount owed. Even if the number of individuals 
involved in these schemes is a fraction of the reported estimate of 1 
to 2 million, IRS’s staff may be challenged to audit them and maintain 
its current audit coverage as well. IRS’s face-to-face audits have 
been declining, decreasing from nearly 400,000 in fiscal year 1999 to 
nearly 200,000 in fiscal year 2001. 

Accordingly, IRS has begun considering whether other techniques than 
audits could be used to resolve these cases. For example, IRS is 
considering options such as disclosure initiatives, settlement 
initiatives, and self-correction programs. These techniques will need 
to be tested and refined to determine which, if any, are effective. 

The increased scope of abusive tax schemes has also led IRS to: 

* develop an improved process for selecting the best cases to pursue 
among the many that it identifies, 

* develop a new policy to govern simultaneous criminal and civil 
enforcement investigations of taxpayers, 

* consider how to ensure that increased volumes of scheme-related tax 
assessments are followed up by IRS’s collection function when 
taxpayers are unable to pay in full, and, 

* use its internal research group and a contractor to develop better 
models for identifying indicators that taxpayers may be participating 
in abusive tax schemes. 

In addition, a significant organizational change has just been 
implemented in SB/SE that is intended to increase program oversight 
and coordinate programs and units dealing with abusive schemes and 
related tax fraud activities. To that end, in the past few weeks SB/SE 
has divided its Office of Flow-Through Entities and Abusive Tax 
Schemes. Now, its efforts to ensure accurate reporting of income 
connected to flow-through entities will fall under a director for 
reporting compliance. IRS separated the flow-through entity effort 
from other abusive tax scheme efforts because it judged that the flow-
through effort is more related to its traditional information-matching 
and examination programs than to its abusive scheme efforts. The flow-
through effort will, however, also provide useful information for IRS 
to use elsewhere in investigations of abusive schemes. 

The rest of SB/SE’s major programs and efforts that are more directly 
focused on abusive tax schemes—the National Fraud program, the Abusive 
Tax Schemes program, the Lead Development Center, and the Anti-Money 
Laundering program—have been placed under a single executive for 
reporting enforcement. Monitoring the Internet and other media outlets 
where abusive tax schemes often are advertised will also be part of 
this centralized effort. 

To date, however, IRS has not provided information on its staff year 
investments in combating abusive tax schemes and has not established 
performance goals and measures that IRS and Congress can use to gauge 
whether these efforts are achieving desired results. We testified 
recently that the IRS commissioner identified four major areas of 
systematic noncompliance. These areas not only focus heavily on 
abusive tax schemes involving individuals, but also include corporate 
tax shelter activity. The fiscal year 2003 budget request includes 
increased resources for compliance efforts, but, excluding the Earned 
Income Credit program, it is unclear from IRS’s congressional budget 
justification how many resources IRS intends to devote to major areas 
of noncompliance or what performance measures will be available to 
Congress and IRS to assess progress. 

Conclusions: 

IRS has long-standing programs and related efforts aimed at detecting 
and dealing with abusive tax schemes, particularly those related to 
frivolous tax returns and fraudulent tax refund claims. Recently, IRS 
has begun to take a more assertive and coordinated approach to 
detecting and dealing with an ever-changing array of schemes, 
including those involving the use of domestic and offshore trusts. In 
the past year, IRS has added more resources to these efforts, created 
new programs, and improved others, and it is reorganizing its 
operations. Furthermore, based on the limited data available, IRS 
appears to be realizing some increased success in convicting those 
involved in schemes, publicizing these results, and uncovering 
previously hidden major offshore compliance problems. 

Nevertheless, it is difficult to get a clear picture of all that is 
underway in IRS how much is new as opposed to reemphasized or 
reorganized, and how the pieces combine to form a planned, coordinated 
effort with specific, defined outcomes. One of the difficulties we 
encountered in gathering information was that no central office, 
group, or executive could provide us with an agencywide focus or 
perspective on IRS’s strategy, goals, objectives, performance 
measures, or program results. Responsibility for the efforts was 
spread across various functions and groups within IRS. To some extent 
this lack of clarity is not surprising given the fairly rapid and 
ongoing change in IRS’s efforts, the expanding scope of the problem, 
and the difficulty in determining the difference between what is 
legitimate, aggressive tax planning and an abusive tax scheme. 

IRS has recognized that its multiple, enhanced efforts need to be 
better integrated. In an attempt to bring this integration to 
fruition, SB/SE is reorganizing to place key efforts to combat abusive 
schemes under one executive. A centralized focal point should enhance 
IRS’s ability to manage its efforts to reduce the prevalence or 
magnitude of abusive tax schemes. 

To date, IRS has not provided information on its staff year investment 
in combating abusive schemes and has not established goals and 
measures for its efforts that it and Congress can use to assess its 
progress. We recently suggested that another committee consider asking 
IRS to provide more specifics on the level of resources it plans to 
devote to areas identified by the commissioner, such as abusive tax 
schemes, and on performance goals and measures for those efforts. This 
committee might want to consider requesting similar information from 
IRS. 

Mr. Chairman, that concludes my statement. I would be pleased to 
respond to questions that you or other members of the committee may 
have at this time. 

[End of section] 

Footnotes: 

1. Although overlap may exist between the types of abusive tax schemes 
used by individuals and other tax paying entities, like corporations, 
our work focused on those schemes generally used by individuals to 
inappropriately reduce the taxes they owe, or to generate refunds to 
which they are not properly entitled. 

2. The FY 2003-2004 SB/SE Strategic Assessment Report (Mar. 1, 2002) 
provides IRS assessment of critical trends, issues, and problems 
facing the Small Business and Self-Employed taxpayer customer segment. 

3. IRS is not able to detect and stop every frivolous refund scheme. 
For example, IRS reported that in tax year 2000 about $13 million in 
refunds was sent to taxpayers due to reparations filings. IRS has 
subsequently taken action to recover the funds. 

4. As part of a reorganization within SB/SE, the responsibilities of 
the Flow-Through Entities and Abusive Tax Schemes office were 
undergoing change in April 2002. We discuss these changes later in the 
testimony. 

5. The schedule K-1 is an information return that a flow-through 
entity sends to partners and beneficiaries with a copy to IRS. The 
schedule K-1 provides information on income distributed to partners 
and beneficiaries. 

6. Other divisions within IRS also work to publicize IRS’s activities 
related to abusive tax schemes. For example, SB/SE devotes part of its 
Internet site to fraud alerts and press releases. 

[End of document]