From the U.S. Government Accountability Office, www.gao.gov Title: Simplified Example of a Tax Evasion Scheme Using a Network Description: This video illustrates how a tax evasion scheme called an installment bogus optional basis transaction (iBOB) works. Associated Publication Number: GAO-10-968 Issue Date: 10/26/2010 Transcript annotated with descriptive text. [Video begins with title page with the following words visible: “Addendum to GAO-10-968, Tax Gap: IRS Can Further Develop Its Efforts to Address Tax Evasion by Networks of Businesses and Other Related Entities”] Taxpayers intent on evading federal taxes have invented numerous schemes to hide income from the Internal Revenue Service. One example is what the IRS calls an installment sale bogus optional basis transaction, or iBOB. [Title page disappears and the words “Installment Sale Bogus Optional Basis Transaction iBOB” appear centered on the screen.] In an iBOB, a taxpayer uses a network of entities he or she owns or controls to artificially increase an asset's purchase price, or basis. This reduces or eliminates capital gains taxes, when the asset is sold. How iBob schemes work is well known to the IRS. This video explains these schemes and the challenges IRS faces in ensuring those who are engaged in such schemes are caught. [IBOB Wording disappears. A network chart showing an arrow connecting an icon of Mr. Jones to an icon of JonesCo appears and then a separate arrow connecting the JonesCo icon to a NewCo icon appears.] Let's say Mr. Jones has a network of related entities. He is a 99 percent partner in JonesCo., which in turn is a 99 percent partner in NewCo. The other partners in these partnerships may also be entities in Mr. Jones' network. NewCo, owns a single asset, a hotel, which was purchased for $120 and is now worth $200. [An icon of a hotel appears within the NewCo icon.] This means there would be a capital gain of $80 when the hotel is sold. JonesCo, as a 99 percent partner in NewCo, has a basis of about $119 in NewCo, and would be entitled to $198 of the hotel's value. [A chart with three columns appears in a bar along the bottom of the screen. The left column is labeled Hotel and the right column is labeled JonesCo's 99 percent share. The first row of the column shows the market value of the hotel to be $200 and JonesCo's 99 percent share of that market value to be $198. The second row of the chart shows the hotel to have a basis of $120 and JonesCo's 99 percent share to be $119. The third row shows the possible capital gain from selling the hotel to be $120 and JonesCo's 99 percent share to be $79.] Mr. Jones wants to sell the hotel and evade the taxes on most of his capital gains. Mr. Jones causes JonesCo to sell its 99 percent partnership interest in NewCo to another entity he controls, the Family Trust. [On the networks chart, an icon for the family trust appears with an arrow connecting Mr. Jones to the Family Trust.] In return, the Family Trust signs a note agreeing to pay $198 in installments to JonesCo. [The figure $198 appears and moves from the Family Trust icon to JonesCo. Simultaneously, the arrow connecting JonesCo and NewCo disappears and an arrow connecting the Family Trust to NewCo appears.] The $198 becomes the Family Trust's basis in NewCo. If the Family Trust were truly independent from Mr. Jones, he would have a reason to make sure the Family Trust made the payments, and JonesCo would report the payments to IRS. When all of the installments were made, JonesCo would have paid the capital gains tax on the difference between the $198 sales price and its basis of $119. This difference is $79. [First chart in lower section of screen disappears. A new chart is shown with three columns, with the left column labeled JonesCo's Former 99 percent Share and the right column labeled Family Trust's 99 percent share. The first row shows the market value of JonesCo's Former 99 percent Share to be $198 and the Family Trust's 99 percent Share to be $198. The second row shows the basis of JonesCo's Former 99 percent Share to be $119 and the Family Trust's 99 percent Share to be $198. The third row shows the capital gain to be $79 for JonesCo's Fomer 99 percent Share and $0 for the Family Trust's 99 percent Share.] But in the iBOB, the installment payments are never made. [The figure $198 moved to the center of the screen, becomes covered by a red slash and circle, and is surrounded by exploding fireworks.] The Family Trust is simply a strawman inside Mr. Jones' network used for triggering a basis adjustment. The fictitious sale permits the NewCo partnership to step up the basis in the hotel to $198 for the new partner, the Family Trust. In other words, the Trust's share of NewCo.'s basis in the hotel rises from $119 to $198. Not only does the fictitious installment sale to the trust improperly raise the trust's share of NewCo.'s basis in the hotel, but it adds complexity that would make it difficult for IRS to follow the flow of funds during a potential audit. [The chart showing Mr. Jones's network recedes to the upper left corner. An Icon for Mr. Brown appears in the lower right. An arrow connecting Mr. Jones's network to Mr. Brown appears, with the figure $200 moving from Mr. Brown to NewCo. After the $200 moves to NewCo, the icon of the hotel moves from NewCo to Mr. Brown.] When NewCo finally sells the hotel to Mr. Brown, a party outside of Mr. Jones' network, for $200, Mr. Jones' Family Trust pays no capital gains taxes because its share of the basis in the hotel and its share of the sales amount match at $198. The government loses nearly all of the potential tax due on the sale from Mr. Jones' network. In the real world, iBOBs could be much more complex by having many layers of network transactions between the installment note being made, the bogus basis adjustment, and the actual sale of the asset. Taxpayers also may let years pass between the basis adjustment and the sale. Performing transactions among many commonly owned organizations and spreading those transactions out over time are typical of the challenges IRS faces in addressing network tax evasion. [Chart on bottom of screen vanishes and the following information appears to replace it: “For more information on IRS's efforts to address network tax evasion and our recommendations on how to build on those efforts, please go to http://www.gao.gov/products/GAO-10-968 and see our report, GAO-10-968, Tax Gap: IRS Can Further Develop Its Efforts to Address Tax Evasion by Networks of Businesses and Other Related Entities.]