GAO-11-318SP: General government: IRS needs an agencywide approach for addressing tax evasion among the at least 1 million networks of businesses and related entities

General government

IRS needs an agencywide approach for addressing tax evasion among the at least 1 million networks of businesses and related entities

Why Area Is Important

At least 1 million networks involving partnerships, trusts, corporations, and similar entities existed in the United States in tax year 2008. These networks can serve a variety of legitimate business purposes. However, transactions made among related entities within networks also can be used in tax evasion schemes to hide taxable income or shift expenses. Such schemes—such as the one described in the text box below—result in lost tax revenue and are difficult for the Internal Revenue Service (IRS) to identify, due to data limitations.

IRS recognizes the risk from network-related tax evasion and is developing new tools and programs to better identify such evasion. These IRS efforts are in various stages of development, but their potential effectiveness in terms of cost savings or added revenue, is not known. However, GAO has identified the need for additional efforts to strengthen enforcement in the networks area and to assess progress.

What GAO Found

IRS knows that many questionable tax shelters and abusive transactions rely on the links among commonly owned entities in a network, but it does not have estimates of the associated revenue loss in part because data do not exist on the population of networks. IRS generally addresses network-related tax evasion through its examination (audit) programs. These programs traditionally involve identifying a single return from a single tax year and routing the return to the IRS division that specializes in auditing that type of return. From a single return, examiners may branch out to review other entities if information on the original return appears suspicious. However, this traditional approach does not align well with how network tax evasion schemes work. Such schemes can cross multiple IRS divisions or require time and expertise that IRS may not have allocated at the start of an examination. A case of network tax evasion also may not be evident without looking at multiple tax years.

Network Scheme Example: Installment Sale Bogus Optional Basis Transaction (iBOB)

An iBOB is an example of a network-related tax evasion scheme that shows how networks pose enforcement challenges for IRS. In an iBOB, a taxpayer uses multiple entities, all owned or controlled by the taxpayer, to artificially adjust the basis of an asset to evade capital gains taxes. The scheme can involve multiple transactions and take place over many tax years, making it difficult for IRS to detect. A short video illustrating the iBOB is available at http://www.gao.gov/products/GAO-10-968.

IRS is developing programs and tools that more directly address network tax evasion. One, called Global High Wealth Industry, selects certain high-income individuals and examines their network of entities as a whole to look for tax evasion. Another, yK-1, is a computerized visualization tool that shows the links between entities in a network. These efforts show promise. They represent new analytical approaches, have upper-management support, and cut across divisions and database boundaries. However, there are opportunities for more progress. For example, IRS has no agencywide strategy or goals for coordinating its network efforts. A strategy would include assessing of IRS's network tools and determining the value of incorporating more data into its network programs and tools—neither of which IRS has done. Without a strategy and assessments, IRS risks duplicating efforts and managers will not have information about the effectiveness of the new programs and tools that could inform resource allocation decisions.

Actions Needed

GAO recommended in its September 2010 report that IRS create an agencywide strategy with goals to coordinate and plan its enforcement efforts on network tax evasion. The strategy should include assessing the effectiveness of network analysis tools to ensure that resources are being devoted to those that provide the largest return on investment; determining whether to increase access to IRS data or collect new data for network analysis; developing network analysis tools on a specific time schedule; and deciding how to manage network efforts across IRS. IRS should ensure that its staff understand the network tools and establish formal ways for users to interact with tool programmers and analysts to ensure that the network tools are easy to use and achieve goals. IRS agreed with GAO's recommendations and said it would make plans to take actions on them but it is too early to determine IRS's progress.

Estimates are not available on the potential for increased tax revenues because IRS has not measured the potential impact of its network efforts on reducing tax noncompliance due to data limitations, but these efforts have significant potential, based on the number of networks that exist.

Framework for Analysis

The information contained in this analysis is based on the related GAO product listed under the "Related GAO Products" tab.

Area Contact

For additional information about this area, contact James White at (202) 512-9110 or whitej@gao.gov.

Related GAO Products

Tax Gap:

IRS Can Improve Efforts to Address Tax Evasion by Networks of Businesses and Related Entities
GAO-10-968:
Published: Sep 24, 2010. Publicly Released: Oct 25, 2010.