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entitled 'Internal Revenue Service: Challenges Remain in Combating 
Abusive Tax Schemes' which was released on December 19, 2003.

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Report to the Chairman and Ranking Minority Member, Committee on 
Finance, U.S. Senate:

November 2003:

Internal Revenue Service:

Challenges Remain in Combating Abusive Tax Schemes:

GAO-04-50:

GAO Highlights:

Highlights of GAO-04-50, a report to the Chairman and Ranking Minority 
Member, Committee on Finance, U.S. Senate

Why GAO Did This Study:

Abusive tax avoidance schemes could threaten our tax system’s 
integrity and fairness if honest taxpayers believe that significant 
numbers of individuals are not paying their fair share of taxes. 
Abusive schemes encompass such distortions of the tax system as 
falsely describing the law (saying, for example, that the income tax 
is unconstitutional), misrepresenting facts (for instance, promoting 
the deduction of personal expenses as business expenses), or using 
trusts or offshore bank accounts to hide income.

As agreed, this report focuses on three objectives. They are to (1) 
describe the nature and scope of abusive tax avoidance schemes as 
determined by the Internal Revenue Service (IRS), (2) describe IRS’s 
strategy to combat these schemes and the performance goals and 
measures IRS uses to track its major effort related to them, and (3) 
describe how IRS determined the amount and source of staff resources 
to be devoted to these schemes in the IRS operating division most 
directly affected.

What GAO Found:

Abusive schemes vary in nature, and new ones continually emerge, 
making it very difficult to measure their extent. IRS has been 
gathering information to better define the scope of abusive schemes. 
In addition to 131,000 participants linked to abusive schemes between 
October 1, 2001, and mid-August 2003, IRS officials estimated that 
several hundred thousand others likely are engaged in abusive schemes. 
However, IRS documented this estimate only when GAO asked. 
Documentation can help policymakers judge the appropriateness of IRS 
resources and strategy in combating the high-priority abusive scheme 
problem.

IRS’s broad-based strategy for addressing abusive schemes included: 

* targeting promoters to head off the proliferation of abusive 
schemes and to identify taxpayers taking advantage of them; 
* offering inducements to taxpayers to come forth and disclose their 
use of questionable offshore tax practices; and
* using performance indicators to measure outputs and intending to 
continue down the path it has started and develop long-term process 
and results-oriented performance goals and measures linked to those 
goals. The lack of these latter elements impedes gauging IRS’s 
progress in combating abusive schemes.

Using a systematic agencywide decision-making process, IRS planned to 
shift significant resources to support its strategy, but the level of 
resources likely to be used in fiscal year 2003 was less than 
expected due to overly optimistic workload forecasts caused by 
inexperience with the types of cases involved. Future resource usage 
remains to be seen, given uncertainty about how much abusive scheme 
work IRS will have and how long it will take to close cases. IRS’s 
understanding of how many staff will be needed to address the problem 
over what period will continue to evolve as IRS gains a better 
understanding of the problem’s scope.

What GAO Recommends:

GAO recommends that when IRS prepares future estimates of the size of 
the abusive scheme problem, the Commissioner of Internal Revenue 
document the support underlying the estimates. In written comments on 
a draft of this report, the Commissioner agreed with this 
recommendation. 

www.gao.gov/cgi-bin/getrpt?GAO-04-50.

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 brostekm@gao.gov.

[End of section]

Contents:

Letter: 

Results in Brief: 

Background: 

Nature of Abusive Schemes Varies and Their Scope Is Unknown: 

IRS Strategy to Combat Abusive Schemes Is Broad-Based, but Has No Long-
term Performance Goals or Measures Linked to Goals: 

IRS Planned Resource Shifts Are Significant, but Resource Use Started 
Slowly and Future Use Remains to Be Seen: 

Conclusions: 

Recommendation to the Commissioner of Internal Revenue: 

Agency Comments: 

Appendix:

Appendix I: Comments from the Internal Revenue Service: 

Tables: 

Table 1: Descriptions of Abusive Scheme Categories: 

Table 2: Comparison of Different Estimates of the Number of Taxpayers 
Involved in Abusive Schemes: 

Table 3: Planned Shift in Revenue Agent and Tax Compliance Officer FTE 
Positions Devoted to Abusive Scheme Priority Areas, Fiscal Years 2002-
2004: 

Table 4: Planned and Projected Revenue Agent and Tax Compliance Officer 
FTEs Devoted to Abusive Scheme Priority Areas, Fiscal Year 2003: 

Table 5: Comparisons of Inventory Developments with Inventory 
Expectations: 

Letter November 19, 2003:

The Honorable Charles E. Grassley: 
Chairman: 
The Honorable Max Baucus: 
Ranking Minority Member: 
Committee on Finance: 
United States Senate:

Abusive tax schemes encompass such distortions of the tax system as 
falsely describing the law (saying, for example, that the income tax is 
unconstitutional), misrepresenting facts (for instance, promoting the 
deduction of personal expenses as business expenses), or using trusts 
or offshore bank accounts to hide income. During an April 2002 hearing 
before the Senate Committee on Finance, we testified about the inexact 
process for estimating the extent of abusive schemes used by individual 
taxpayers.[Footnote 1] We pointed to Internal Revenue Service (IRS) 
estimates that about 740,000 taxpayers had used certain types of 
abusive schemes in tax year 2000, and that $20 billion to $40 billion 
in improper tax avoidance or tax credit and refund claims had occurred 
that IRS had not yet been able to identify and address. We noted that 
abusive schemes could threaten our tax system's integrity and fairness 
if honest taxpayers believe that significant numbers of individuals are 
not paying their fair share of taxes.

The estimated 740,000 taxpayers consisted of estimates of the number of 
taxpayers in four major scheme areas--about 62,000 with frivolous 
returns, 105,000 with frivolous refunds, 65,000 using abusive domestic 
trusts, and 505,000 using offshore schemes. Of the 505,000 taxpayers 
estimated to use offshore schemes, IRS estimated 500,000 were abusing 
offshore credit cards. In our testimony, we discussed how IRS arrived 
at its estimates. We also understand that some of the estimates 
reflected high-end numbers, for example, the numbers of taxpayers who 
were associated with a particular abusive promoter, but not necessarily 
reflecting an abusive scheme on their tax returns.

The $20 billion to $40 billion estimate of taxes not identified and 
addressed related to offshore schemes. Saying there were no reliable 
data to predict tax implications, IRS derived its estimate based on 
average dollars in other parts of the abusive tax scheme program.

As agreed, this report focuses on three objectives. They are to (1) 
describe the nature and scope of abusive tax avoidance schemes as 
determined by IRS, (2) describe IRS's strategy to combat these schemes 
and the performance goals and measures IRS uses to track its major 
effort related to them, and (3) describe how IRS determined the amount 
and source of staff resources to be devoted to these schemes in the IRS 
operating division most directly affected. To do our work, we (1) 
analyzed IRS and other scheme reports, publications, data, and other 
documentation providing insight into the characteristics, complexity, 
size, and type of the problem, (2) reviewed IRS planning documents with 
information on IRS strategies, measures, milestones, and resources, (3) 
compared the contents of IRS planning documents to Government 
Performance and Results Act of 1993[Footnote 2] (GPRA) criteria on what 
elements strategic planning should include, and (4) interviewed agency 
officials about their views on, among other things, the problem's 
nature and scope and IRS's strategy. We did our work from September 
2002 through September 2003 in accordance with generally accepted 
government auditing standards.

Results in Brief:

Abusive schemes vary in nature, and new ones continually emerge, making 
it very difficult to measure their extent. IRS has been gathering 
information to better define the scope of abusive schemes. In addition 
to 131,000 participants who were linked to abusive schemes between 
October 1, 2001, and mid-August 2003, IRS officials estimated that 
several hundred thousand additional taxpayers likely are engaged in 
abusive schemes. Officials have not estimated how many tax dollars 
might be involved overall. IRS's estimate of those involved is 
primarily based on promoter-related information developed in the past 
year and includes only those offshore credit card cases where IRS 
believes individuals' names are likely to be identified. Although they 
did not originally have documentation supporting this estimate, upon 
request, IRS officials prepared documentation for us showing the 
estimate's derivation. Documenting the basis for key program-related 
numbers ensures that others can judge their reliability and better 
understand what may account for differences in such key numbers over 
time. IRS continues to believe abusive schemes represent a significant 
compliance problem that deserves considerable attention, and schemes 
remain a top enforcement priority.

IRS's broad-based strategy for addressing abusive schemes included the 
following:

* targeting promoters to head off the proliferation of abusive schemes 
and to identify taxpayers taking advantage of them;

* offering inducements to taxpayers to come forth and disclose their 
use of questionable offshore tax practices;

* focusing attention on identifying schemes, alerting the public, and 
enforcing the law, including partnering with states to share 
information on abusive schemes;

* promoting the coordination of efforts throughout IRS; and:

* using performance indicators to measure outputs and intending to 
continue down the path it has started and develop long-term process and 
results-oriented performance goals and measures linked to those goals. 
The lack of these latter elements impedes gauging IRS's progress in 
combating abusive schemes.

IRS is in the midst of its efforts to implement its abusive scheme 
strategy and has had to make decisions about staff allocations and what 
can be accomplished on the basis of available information. Using a 
systematic agencywide decision-making process, IRS planned to shift 
resources, significantly in the case of examination resources, to 
support its strategy, but the level of resources used in fiscal year 
2003 through July 31 and likely to be used in fiscal year 2003 as a 
whole was less than expected due to overly optimistic workload 
forecasts caused by inexperience with the types of cases involved. The 
extent to which the caseload and resources will match each other in the 
future remains to be seen, given the uncertainty about the volume of 
additional work and the rate at which IRS can close abusive scheme 
examinations. IRS's understanding of how many staff will be needed to 
address the program and how long staff will take to work through the 
cases will continue to evolve as IRS gains a better understanding of 
the scope of abusive schemes.

To ensure that support for future IRS estimates of the size of the 
abusive scheme problem exists, we are recommending that IRS document 
the support when preparing the estimates.

In written comments, the Commissioner of Internal Revenue agreed with a 
draft of this report. He specifically agreed with the recommendation 
and said that IRS would establish a methodology for documenting the 
basis for the estimates. He also affirmed IRS's intention to establish 
measurable process and results-oriented goals and said that developing 
these measures is an operational priority for fiscal year 2004.

Background:

In a June 2002 letter, the Secretary of the Treasury addressed various 
questions posed by the then Ranking Member of the Committee on Finance 
on IRS actions to address abusive schemes. Treasury's letter pointed to 
IRS's Small Business/Self-Employed (SB/SE) Division as having primary 
responsibility for abusive schemes marketed to individuals and small 
businesses.

Within SB/SE, several units have established combating abusive schemes 
as a top priority. The Office of Reporting Enforcement was established 
in 2002 to increase program oversight and to help information flow 
among programs that address abusive schemes. SB/SE's collection 
component is to work closely with the examination function to ensure 
coordination. Its Taxpayer Education and Communication unit has 
launched a countermarketing strategy against abusive tax schemes and 
their promoters. Its Communications and Liaison unit is responsible for 
developing communication messages and strategies to maintain and 
enhance ongoing IRS interaction with internal and external 
stakeholders.

Other IRS organizations are also involved with abusive schemes. For 
instance, Criminal Investigation (CI) works closely with SB/SE and 
investigates and pursues promoters and individuals using schemes. The 
Office of Chief Counsel provides legal services, such as publishing 
guidance, working with examination and collection activities, and 
pursuing litigation.

Nature of Abusive Schemes Varies and Their Scope Is Unknown:

The nature of abusive tax schemes is both varied and evolving. We 
testified last year that as schemes are often hidden, estimates 
presented in 2002 of the extent of abusive tax avoidance were inexact 
at best. IRS efforts underway to more definitively identify the scope 
of the problem revealed that, for the period from October 1, 2001, 
until mid-August 2003, 131,000 participants were involved in abusive 
schemes. For the 72,600 of these participants identified by February 
28, 2003, IRS estimated that about $1.6 billion in taxes were or might 
be recaptured, with more to be determined. In addition, on the basis of 
the number of promoters identified and the amount of information not 
yet received or processed, IRS officials estimated that hundreds of 
thousands of other taxpayers were involved in abusive schemes, but they 
did not prepare supporting documentation when making the estimate. 
According to IRS, recent estimates resulted from knowledge gained over 
the last year focusing on more specific information than previously 
used.

Abusive Schemes Vary and New Ones Continually Emerge:

Abusive schemes include various kinds of arrangements designed to 
circumvent tax laws or evade taxes. As we testified last year, they can 
run from very simple to very complex, from clearly illegal to those 
carefully constructed to disguise the illegality of the scheme. Users 
of schemes can range from those believing their position is correct to 
those who knowingly but willfully file incorrect tax returns.

As shown in table 1, SB/SE sorts abusive schemes into seven categories. 
They range from trust arrangements to those claiming no legal basis for 
federal income taxes to tax shelters bought by taxpayers that are under 
SB/SE's auspices. In the case of the latter, SB/SE is responsible for 
investigating abusive shelters used by high-wealth individuals with 
complex tax returns and by businesses with assets of less than $10 
million.

Table 1: Descriptions of Abusive Scheme Categories:

Category of scheme: Abusive trust schemes; Description of the category: 
Arrangements featuring layers of trusts, with each trust distributing 
income to the next layer to fraudulently reduce taxable income to 
nominal amounts.

Category of scheme: Deduction/expense schemes; Description of the 
category: False representations of facts to claim improper deductions.

Category of scheme: Refund/credit schemes; Description of the category: 
Schemes involving the creation of credits to substantially reduce tax 
or create refunds.

Category of scheme: Antitax arguments; Description of the category: 
Arguments that entice people to believe collecting federal income taxes 
has no legal basis.

Category of scheme: Exempt organization schemes; Description of the 
category: Schemes using a tax-exempt entity to obtain unallowable 
benefits.

Category of scheme: Tax shelters; Description of the category: Very 
complicated transactions that sophisticated tax professionals promote, 
exploiting tax loopholes and reaping large and unintended tax benefits.

Category of scheme: Offshore compliance schemes; Description of the 
category: Schemes in which the true ownership of income streams and 
assets is hidden to improperly shield financial activity from the U.S. 
tax system.

Source: IRS data compiled by GAO.

[End of table]

According to IRS officials, the popularity of schemes can also vary. 
Officials have seen a decline in slavery reparation schemes over time, 
and they have also become aware of new schemes that abuse corporate 
"soles" (one-member religious entities used to claim that income is tax 
free) and the disabled access credit (used to reduce taxes or create 
refunds). One SB/SE official explained that scheme promoters try to 
stay in the business of tax avoidance; when one type of scheme is 
discovered and addressed, another scheme will take its place.

Scope of Abusive Schemes Is Unknown:

The full scope of the abusive tax scheme problem is unknown because 
estimates are difficult to make based on imperfect data. As we 
testified last year, estimating the extent of abusive schemes used by 
individual taxpayers is at best an inexact process because these 
schemes are often hidden.

In fiscal year 2003, SB/SE tried a new approach to improve its 
information about the problem and help with its work planning process. 
The new approach differed from prior efforts in that it focused on what 
IRS had actually found. The effort's aim was to develop an inventory of 
abusive schemes and related data in order to develop an overall 
strategy for addressing abusive schemes and to enhance the work 
planning process. In this context, SB/SE developed a template for 
organizing information about known schemes and known investors. The 
template took the form of a matrix to be used to compare the risks 
presented by various schemes along the lines of factors such as the 
number of cases available for IRS staff to review but as yet unstarted, 
the number of promoters, the amount of money involved, and the number 
of taxpayers participating. The matrix organizes abusive schemes within 
the seven categories shown above in table 1.

According to a summary of items in the matrix categories and IRS's work 
with offshore credit cards covering October 2001 through mid-August 
2003, IRS identified about 131,000 participants in abusive schemes. 
This number included 22,000 participants in the offshore credit card 
area and, according to SB/SE, reflected the best available data, but 
not a potential universe. It updated a previous summary covering 
October 1, 2001, through February 2003 that showed 72,600 potential 
participants. In that summary, SB/SE noted that recaptured or 
potentially recaptured taxes from closed or identified reviews totaled 
almost $1.6 billion, excluding undetermined amounts from the credit 
card work. That summary also included the 22,000 participants in the 
offshore area, but IRS was not able to update this figure for its later 
summary because new credit card information had just arrived.

IRS used an estimate in its fiscal year 2005 budget presentation of the 
number of taxpayers it believes are involved in abusive schemes who are 
likely to be identified through its various efforts. IRS estimated that 
more than 400,000 taxpayers fall into this category, generally 
including the approximately 131,000 participants it had identified as 
of mid-August 2003. According to IRS officials, this estimate was 
included in materials provided to the Department of the Treasury and 
the Office of Management and Budget during budget discussions. It was 
used not as a basis for requesting resources sufficient to examine the 
taxpayers, but to show that the abusive scheme problem was large 
relative to current resources. According to IRS officials, this 
estimate was developed during a series of meetings, but documentation 
showing the basis for the estimate was not prepared at that time.

We are unaware of a specific IRS or other policy that requires 
contemporaneous documentation of a figure like the 400,000 estimate of 
taxpayers IRS expects to identify as engaged in abusive schemes. 
Nevertheless, documenting the basis for key numbers related to an 
agency's programmatic efforts is in line with the thrust of management 
legislation and IRS's own policies. For example, GPRA stresses not only 
that agencies develop measures of program performance, but also that 
the measures be valid and reliable. IRS too stresses that program 
managers have valid and reliable measures of program performance in its 
Strategic Planning, Budgeting, and Performance Management Process. 
Although the 400,000 estimate is not an IRS program performance 
measure, it is a measure that IRS has used in discussions on its fiscal 
year 2005 budget needs. Further, Congress has expressed interest in the 
specific issue of abusive schemes, including through this review, which 
has focused in part on the nature and scope of abusive tax schemes. 
Documenting the basis for key program-related numbers ensures that 
others can judge their reliability and better understand what may 
account for differences in such key numbers over time.

At our request, IRS prepared a document showing how the estimate of 
over 400,000 was derived. IRS based this estimate to a great extent on 
the promoters it had identified, but for which it had not yet received 
investor lists. If each investor list contained only the average number 
of names identified on the very few lists considered so far, a 
conservative assumption according to SB/SE's Deputy Director, 
Compliance Policy, more than 300,000 taxpayers would be involved. In 
addition, although IRS had not yet processed most of the offshore 
credit card information it had received, staff projected that tens of 
thousands of abusive credit card users were likely to be identified. 
According to the same official, IRS now believes more taxpayers are 
engaged in various abusive schemes not involving offshore credit cards 
than it did last year but fewer than it believed last year are engaged 
in schemes involving offshore credit cards and likely to be identified. 
Not wanting to overstate the total number of taxpayers likely to be 
identified as involved in abusive schemes, IRS adopted a conservative 
estimate of more than 400,000, emphasizing to us that its program is 
still in the developmental stage and the number is probably higher. 
Table 2 compares how the 400,000 relates to the numbers used in our 
testimony from last year. Because some of the numbers are estimates 
based on limited information and because the specific types of cases 
included in the different categories are not always identical, the 
comparisons are only a general indication of changes in the potential 
size of the scheme categories and the total number of taxpayers 
involved.

Table 2: Comparison of Different Estimates of the Number of Taxpayers 
Involved in Abusive Schemes:

Scheme area[A]: Offshore credit cards and other schemes; February 2002 
estimate: 570,000; October 2003 estimate: More than 400,000.

Scheme area[A]: Frivolous returns; February 2002 estimate: 62,000; 
October 2003 estimate: 21,000[B].

Scheme area[A]: Frivolous refunds; February 2002 estimate: 105,000; 
October 2003 estimate: 127,000[B].

Scheme area[A]: Total; February 2002 estimate: 737,000; October 2003 
estimate: More than 548,000.

Source: Derived by GAO from IRS data.

[A] The types of schemes included in the different categories in the 
two periods were not consistent, but the differences were small 
relative to the total number of taxpayers involved.

[B] These numbers are for fiscal year 2002.

[End of table]

IRS has not associated a dollar amount with its estimate of more than 
400,000 taxpayers, although it believes the amount is substantial. 
According to SB/SE's Deputy Director, Compliance Policy, IRS is trying 
to be more data-driven in this area and is not tracking dollars 
associated with its projection.

In addition to the estimate of more than 400,000 taxpayers, some IRS 
units collected other information regarding abusive schemes that 
identified the scope of other pieces of the problem. These pieces are 
not part of SB/SE's examination workload planning effort because they 
do not involve examinations. IRS's Frivolous Return Program identifies 
returns and refunds for taxpayers whose returns either state an 
argument that IRS can readily identify as frivolous or have 
characteristics IRS has identified as reflecting a frivolous argument. 
The program stopped about 21,000 frivolous returns (as shown in table 
2) and refunds resulting in about $619 million in protected tax dollars 
in fiscal year 2002. CI identified about 127,000 fraudulent refund 
claims in fiscal year 2002 and stopped about $379 million in fraudulent 
refunds.

IRS Strategy to Combat Abusive Schemes Is Broad-Based, but Has No Long-
term Performance Goals or Measures Linked to Goals:

IRS's abusive scheme strategy takes a multipart approach to focus 
resources on the most egregious promoters of, and participants in, 
offshore credit card and other schemes. It entails identifying schemes 
and their participants, alerting the public, enforcing the law, and 
coordinating efforts internally and throughout IRS. Although IRS 
planning documents outline an overall strategy for combating abusive 
schemes, IRS has not yet defined long-term performance goals for the 
effort and the measures it would use to track progress in achieving 
those goals. However, although establishing such goals and measures 
will be challenging, IRS intends to establish process and results-
oriented goals in the future.[Footnote 3]

SB/SE's Strategy Includes Pursuing Egregious Promoters As Well As 
Offshore Credit Card and Other Abusers:

As outlined in planning documents, the SB/SE strategy to combat abusive 
tax schemes focuses on attacking the source of what IRS considers to be 
the most egregious abusive noncompliance. The strategy requires using 
scarce resources to address three high-priority areas--promoters, 
offshore credit card schemes, and other abusive schemes (including 
offshore schemes other than credit card schemes)--all under the 
jurisdiction of a position established in 2002, the Director of 
Reporting Enforcement.

Because promoters generate noncompliance by selling tax avoidance 
schemes to others, they represent a top priority in the strategy. By 
pursuing promoters, IRS may leverage its resources and gain access to 
lists of clients who bought the promoters' products. An SB/SE official 
stated that the focus is to pursue promoters first to stop the growth 
of abusive schemes. IRS can then take enforcement actions against 
participants in abusive schemes.

IRS especially targeted abusive schemes involving credit cards issued 
by offshore banks. Credit cards allow easy access to income hidden in 
accounts in tax haven countries. In October 2000, IRS issued summonses 
to two credit card companies to obtain limited information about U.S. 
citizens holding credit cards issued by banks in three offshore 
financial centers. After lengthy negotiations to address one of the 
company's concerns and reach a compromise for compliance, that company 
provided information in April 2002. In March and August 2002, IRS 
issued a second round of summonses to credit card companies seeking 
records on cards issued by banks in 31 offshore financial centers. The 
scope of records to be produced under these summonses had to be 
negotiated, with consideration given to the burden of requiring full 
compliance, the balance between the amount of information to be 
produced and the time needed to produce it, and the need to focus as 
much as possible on probable U.S. taxpayers.

Because IRS could not always identify individuals based on credit card 
company information, it also issued summonses to 123 merchants for 
additional information that could be used in examinations and criminal 
investigations. Analyzing merchant responses was very time consuming, 
requiring follow-up for more information, and IRS still needed to work 
beyond the merchant information provided to identify taxpayers.

On July 30, 2003, IRS announced that as a result of its credit card 
project, it had continuing or completed audits on 2,800 returns, and it 
had assessed more than $3 million in taxes. As of early August 2003, 
IRS had received records from both rounds of credit card company 
summonses and from almost all of the merchant summonses. It needed to 
go through these records before it would begin to have a better idea of 
the size of the credit card problem, keeping in mind that the merchant 
summonses related only to merchants identified by analyzing data 
produced by one credit card company responding to the first summons.

In January 2003, IRS began a voluntary compliance initiative to 
identify promoters and to return to tax law compliance taxpayers who 
use offshore payment cards to hide income. Under the initiative, 
eligible taxpayers stepping forward before April 16, 2003, would not 
pay certain penalties and would not face criminal prosecution, pending 
acceptance into the program. However, they would agree to provide full 
details on promoters of offshore arrangements. They would also pay 
previously owed taxes, interest, and certain other penalties. In 
addition to this voluntary compliance initiative and to the summonses, 
the Department of the Treasury has entered into tax information 
exchange agreements with offshore financial centers to further improve 
the federal government's information collection.[Footnote 4]

On July 30, 2003, IRS announced that 1,299 taxpayers stepped forward to 
participate in the voluntary compliance initiative, and that analyzing 
cases to date revealed 214 new offshore promoters. According to SB/SE's 
Deputy Director, Compliance Policy, as of mid-September 2003, the 
initiative had led to collecting more than $100 million in tax, a 
figure that continues to grow. The 1,299 taxpayers who volunteered is a 
small number compared to early reports of the scope of the problem. 
However, according to IRS officials, the reality of promoters being 
identified by taxpayers gives IRS data on the source of the problem and 
a wealth of information that can be used to further investigate abusive 
schemes. They said IRS was in the early stages of receiving and 
following up on completed packages of information, but it had already 
received valuable information on how promoted schemes worked. In 
addition, instead of stepping forward, IRS officials say some taxpayers 
seem to have filed amended tax returns, bringing themselves into 
compliance in a different way. IRS did not yet know the number of 
amended returns that arrived as a result of the initiative.

For the abusive schemes shown in table 1, SB/SE's fiscal year 2003 
plans called for developing an inventory of schemes and their status, 
working out a more detailed overall strategy, and developing and 
implementing a process to oversee and manage IRS's efforts to combat 
abusive schemes and promoters. In general, SB/SE officials saw fiscal 
year 2003 as a transition year in which to build an infrastructure for 
full implementation of a strategy in fiscal year 2004. To develop 
inventory information, SB/SE has been devising a matrix to assess the 
risk associated with various abusive schemes. Although it will not 
identify the full scope of the problem, the matrix is intended to help 
SB/SE management prioritize the various schemes it encounters and 
decide how much in resources to allocate to combat each one.

SB/SE's Strategy Includes Identifying Schemes, Alerting the Public, and 
Enforcing the Law:

SB/SE's strategy to combat abusive schemes includes actions to identify 
schemes, alert the public, and identify and take enforcement action 
against promoters and participants. SB/SE identifies promoters and 
participants through disclosure initiatives, Internet research, 
investigations, and examinations. IRS is also partnering with state tax 
agencies to combat abusive schemes. On September 16, 2003, IRS 
announced agreements to, among other things, exchange information about 
abusive schemes identified at the federal and state levels, have IRS 
provide leads on participants in abusive schemes to states for 
investigation, and partner on training and other educational 
activities.

SB/SE's strategy to alert the public includes targeting educational 
outreach and countermarketing strategies to address abusive schemes and 
their promoters. The division's Taxpayer Education and Communication 
(TEC) unit, in conjunction with the Communications and Liaison and 
Reporting Enforcement units and others, created toolkits for abusive 
scheme outreach and education. The toolkits are for external 
stakeholders, such as professional organizations, to educate their 
members and clients and also for use as internal guidance.

Enforcement action against promoters and participants can take many 
forms. For example, IRS criminal investigations can lead to indictments 
and convictions. Similarly, IRS conclusions that injunctions are 
warranted can lead to promoters being enjoined from continuing with 
their promotions. As of May 2, 2003, IRS had 464 ongoing criminal 
investigations of scheme promoters and investors, as opposed to 125 in 
2001, and 27 promoter injunctions granted, compared to 1 about a year 
earlier. IRS can also assert civil penalties or use summonses.

SB/SE's Strategy Is Coordinated within SB/SE and throughout IRS:

Internal coordination is key to SB/SE's approach for addressing abusive 
schemes. Last year we testified that SB/SE was reorganizing to place 
its key efforts to combat abusive schemes under one executive and 
better integrate them. Now SB/SE's Deputy Director, Compliance Policy, 
is charged with coordinating the division's strategy for combating 
abusive schemes and working closely with other IRS operating divisions. 
IRS has also established coordination groups, namely the Abusive Tax 
Evasion, Avoidance Schemes, and Devices Executive Steering Committee 
and the Offshore Credit Card Project Oversight Board, both of which 
include members from different parts of IRS and operate under the 
auspices of IRS's Enforcement Committee chartered in July 2003. Chaired 
by the Deputy Commissioner for Services and Enforcement, the 
Enforcement Committee is to guide IRS-wide enforcement strategies, 
focusing on high visibility issues involving many divisions or 
potentially having significant compliance impact.

IRS units coordinate with each other in various ways in planning and 
implementing actions to combat abusive schemes. For example, in April 
2002, SB/SE established the Lead Development Center (LDC) to centralize 
the nationwide receipt of leads on promoters of abusive schemes. Once 
the LDC organizes promoter information from both agencywide and 
external sources, it coordinates with CI to determine who takes the 
lead in promoter cases of interest to SB/SE and CI and at times to work 
in parallel investigations. Another example of two divisions partnering 
with each other was the plan for SB/SE and the Large and Mid-Size 
Business Division to jointly find ways to identify entities used to 
mask questionable transactions and address their abuse. As part of this 
effort, the two divisions planned to develop and implement a strategy 
to focus on high-income taxpayers investing in flow-through entities 
used to hide taxable income. The planning documents of different IRS 
divisions had cross-references to the plans and work of other 
divisions.

SB/SE also coordinates internally and with other units in its efforts 
to alert the public. TEC and the SB/SE Communications and Liaison unit 
coordinate with SB/SE Compliance and with CI and the Office of Chief 
Counsel when doing outreach and education. For instance, Counsel 
provides legal assistance with language to try to ensure that public 
messages are legally accurate. As another example, Communications and 
Liaison, Compliance, CI, and Counsel personnel all provided TEC with 
input on components of the toolkits TEC developed.

SB/SE Has No Long-term Performance Goals or Measures Linked to Goals:

Although IRS has outlined and begun to implement a strategy for 
combating abusive schemes, it has not yet defined performance goals for 
the effort and established the measures it would use to track progress 
in achieving those goals. Performance goals define what an organization 
is trying to achieve over time, preferably focusing on the outcome 
desired rather than on activities or outputs. IRS officials recognize 
that developing performance goals and associated measures to track 
progress is desirable. Although given the substantial difficulty in 
assessing the scope of the abusive scheme problem, establishing 
performance goals and associated measures will be challenging, IRS 
intends to establish process or results-oriented performance goals in 
the future.

Using business plans and status reports, SB/SE established some short-
term goals and measures to track its abusive scheme activity. It 
established short-term goals, such as developing alternative treatments 
and/or a settlement strategy for offshore credit card cases by November 
1, 2002. (As mentioned earlier, IRS actually began its offshore 
voluntary compliance initiative in January 2003.) SB/SE also used 
measures, such as the number of approved investigations. Although 
establishing these goals and measures represents progress, IRS has not 
developed long-term process and results-oriented performance goals or 
measures associated with them.

SB/SE officials acknowledged the importance of goals and measures and 
are working on improving. As mentioned earlier, one of SB/SE's fiscal 
year 2003 efforts was to develop a detailed overall strategy for 
addressing the abusive schemes described in table 1, including a 
process to oversee and manage the area. SB/SE officials said they would 
devise measures of compliance success once they have their process in 
hand and gain experience. Because the extent of abusive scheme activity 
is unknown and success in addressing it is hard to define, efforts to 
develop long-term performance goals and associated measures are 
difficult. However, consistent with their ongoing efforts to build an 
infrastructure to address abusive schemes, SB/SE management officials 
expressed their intention to establish process and results-oriented 
goals and measures in the future. Progress in developing these elements 
is crucial to being able to communicate progress made in combating 
abusive schemes.

IRS Planned Resource Shifts Are Significant, but Resource Use Started 
Slowly and Future Use Remains to Be Seen:

IRS has begun shifting, although more slowly than expected, and plans 
to continue shifting, significant resources into addressing abusive 
schemes, but the potential volume of additional work that may be 
identified and inexperience with the rate at which staff can close 
cases make it unclear whether the additional resources and the 
caseloads will match each other. At the agencywide level, IRS used a 
systematic decision-making process in deciding to make these shifts. At 
the SB/SE level, executives considered resources available and program 
priorities in significantly increasing SB/SE examination staff 
resources devoted to abusive schemes. In doing so, they planned to 
shift resources out of examining areas such as small corporations and 
nonabusive flow-through entities.

Overall Budget Trade-offs:

IRS decided staffing resource levels to be devoted to addressing 
abusive schemes through a systematic planning and budgeting process, 
albeit one that used participants' experience and judgment in the 
absence of definitive measures of the problem's size. Early in calendar 
year 2002, IRS's divisions, including SB/SE, conducted strategic 
assessments in which they studied trends, issues, and priorities 
affecting their operations. In April 2002, IRS's senior management 
team, including the Commissioner, Deputy Commissioner, division heads, 
and others, went through two rounds of considering IRS's programs to 
prioritize the needs for new or redirected funding for fiscal year 
2004. Of 33 programs considered, abusive schemes received the second 
most votes. According to an IRS official, this process also informed 
how funds already requested for fiscal year 2003 would actually be 
spent.

After the senior management team reached consensus, the Commissioner 
issued overall planning guidance for fiscal years 2003 and 2004 to 
reflect the jointly set strategic direction, and the divisions wrote 
fiscal year 2003 and 2004 "strategy and program plans" outlining staff 
resources needed. Showing its intent to focus resources on detecting 
noncompliance, SB/SE's plan cited an increasing number of abusive 
schemes, an abusive scheme estimate of up to $40 billion, promoters 
using the Internet as their primary way of operating, and the potential 
for abusive schemes eroding taxpayers' confidence in the tax system's 
fairness.

SB/SE Used Priorities to Plan for Significant Resource Shift:

For fiscal years 2003 and 2004, SB/SE significantly increased the 
examination resources it planned to allocate to new priorities, 
including three of its highest: (1) promoters of abusive schemes, (2) 
offshore credit card schemes, and (3) other abusive schemes. As shown 
in table 3, the planned level of resources for these three areas almost 
quadrupled from 267 full-time equivalents (FTE) in fiscal year 2002 to 
1,020 FTEs the next year, and it increased slightly from there to 1,154 
FTEs for fiscal year 2004.

Table 3: Planned Shift in Revenue Agent and Tax Compliance Officer FTE 
Positions Devoted to Abusive Scheme Priority Areas, Fiscal Years 2002-
2004:

Priority area: Promoters of abusive schemes; FY 2002: 16; FY 2003: 150; 
FY 2004: 154; Percentage increase from FY 2002 to 2004: 863%.

Priority area: Offshore credit card schemes; FY 2002: 0; FY 2003: 561; 
FY 2004: 367; Percentage increase from FY 2002 to 2004: -.

Priority area: Other abusive schemes; FY 2002: 251; FY 2003: 309; FY 
2004: 633; Percentage increase from FY 2002 to 2004: 152%.

Priority area: Total; FY 2002: 267; FY 2003: 1,020; FY 2004: 1,154; 
Percentage increase from FY 2002 to 2004: 332%.

Source: IRS data compiled by GAO.

Note: These FTEs include revenue agents and tax compliance officers, 
but not tax examiners who conduct examinations through correspondence. 
Revenue agents and tax compliance officers usually have accounting 
experience and meet directly with taxpayers during the audit. 
Correspondence examinations do not require tax examiners to meet with 
the taxpayer in person.

[End of table]

SB/SE arrived at its fiscal year 2003 budget estimates for different 
categories of abusive schemes in different ways. To estimate the number 
of examiner FTEs needed for promoters, it started with the number of 
approved promoter investigations and assumed another 35 investigations 
would be added each month. It also assumed that each investigation 
would take 37.5 hours per month for 8 months, for a total of 300 hours.

For offshore credit card schemes, SB/SE estimated a potential number of 
participants by extrapolating data from October 2000 summonses to find 
potential credit card abusers. It decided how many participants it 
could actually examine, which was significantly less than the number of 
participants extrapolated, based on the estimated availability of FTEs.

For other abusive schemes, SB/SE estimated a potential number of 
participants by using available data on identified schemes and investor 
lists. It determined how many hours examining relevant returns would 
take by assuming that closing other abusive cases would take certain 
percentages of the time needed for nonabusive returns. Although other 
abusive schemes evolve and past experience will not necessarily bear 
out for the future, for its staff year estimates for other abusive 
schemes IRS officials generally had more relevant experience from prior 
work on abusive schemes to draw upon than they did for promoter and 
offshore credit card staff year estimates.

In determining its budget estimates for all these areas, SB/SE 
considered the allocation to other programs. It did this using input 
from SB/SE executives and examiners in an iterative process. Given the 
shifts to abusive schemes, SB/SE planned to limit the numbers of its 
traditional examinations, such as those of small corporations and 
nonabusive flow-through entities. For instance, it scheduled the number 
of revenue agent FTEs devoted to nonabusive flow-through entities to 
decline from 485 to 176 between fiscal years 2002 and 2003, translating 
to a decrease in the number of returns examined by revenue agents from 
12,318 to 1,078.[Footnote 5] Further, for fiscal year 2003, SB/SE also 
began directing its most skilled examination resources away from 
national programs, such as claims for refunds and cases with tax 
returns identified as being most likely to have their taxes increased 
upon audit. To cope with this shift in resources away from certain 
areas, IRS planned various mitigating efforts, such as first examining 
individuals for abusive schemes and then pinpointing related flow-
through and other entities to be audited, rather than first selecting 
the entities to audit. We did not assess how the shifts in resources 
would affect examination coverage in the areas losing staff or IRS's 
plans to mitigate that effect.

In addition to the increased resources for IRS examination priority 
areas reflected in table 3, other parts of SB/SE and IRS also used or 
planned to use FTEs to address abusive schemes. For instance, within 
SB/SE, although the TEC unit did not specifically allocate FTEs for 
abusive schemes in fiscal year 2002, it planned to devote 54 FTEs to 
addressing abusive schemes in fiscal year 2003 (about 13 had been used 
as of July 26, 2003) and asked for another 125 for fiscal year 2004. 
Similarly, the collection function went from 0 FTEs in fiscal year 2002 
to planning for 73 and 81 FTEs in fiscal years 2003 and 2004, 
respectively. According to an SB/SE official in early August 2003, SB/
SE did not have reliable information on how many FTEs the collection 
function had used to date to address abusive schemes in fiscal year 
2003.

Outside SB/SE, although CI did not budget staff resources specifically 
for abusive schemes, it used 120 FTEs in fiscal year 2002 just on 
abusive domestic and foreign trusts and expected significant cascading 
effects on its scheme work in the form of referrals from other units. 
For fiscal year 2004, it also requested 185 FTEs in addition to the 441 
already used to identify, develop, and analyze potentially fraudulent 
schemes in its Questionable Refund Program and its Return Preparer 
Program. Other SB/SE and IRS areas devoting FTEs to abusive schemes 
include the Frivolous Return Program, SB/SE Communications and Liaison, 
and the Office of Chief Counsel.

Resource Use Differed from Expectations, and Future Use Remains to Be 
Seen:

As of July 31, 2003, IRS had used fewer examination resources combating 
abusive schemes than it had expected. Although IRS intends to 
significantly shift resources to address abusive schemes, how future 
resources will actually be used remains to be seen. The future volume 
of cases IRS will need to examine and the rate at which IRS will be 
able to close examinations are unclear. Instead of using examination 
resources to the extent intended to address abusive schemes, it has 
been able to apply them to other high-priority programs, such as its 
Unreported Income Discriminant Function effort, and if circumstances 
warranted, it could do so again in the future.

As shown in table 4, through July 31, 2003, SB/SE was on track to use 
less than half of the 1,020 fiscal year 2003 FTEs designated for 
abusive scheme priority areas. It was on track to use 10 percent of the 
revenue agent FTEs to be devoted to offshore credit card schemes and 30 
percent of those to be devoted to promoters. IRS officials stated that 
fiscal year 2003 was a transition year and attributed the slower than 
expected start to overly optimistic forecasts for delivering a high 
level of workable cases to revenue agents--forecasts made without the 
experience needed in the promoter and offshore credit card areas to 
gain insight into how slowly or quickly inventory develops. Recent 
trends of more cases starting per month indicate that the available 
workload is growing.


Table 4: Planned and Projected Revenue Agent and Tax Compliance Officer 
FTEs Devoted to Abusive Scheme Priority Areas, Fiscal Year 2003:

Priority area: Promoters of abusive schemes; Planned FTEs: 150; 
Projected FTEs if the pace at July 31, 2003 was maintained: 45; 
Projected FTEs as a percentage of those planned: 30.

Priority area: Offshore credit card schemes; Planned FTEs: 561; 
Projected FTEs if the pace at July 31, 2003 was maintained: 56; 
Projected FTEs as a percentage of those planned: 10.

Priority area: Other abusive schemes worked by revenue agents; 
Planned FTEs: 275; Projected FTEs if the pace at July 31, 2003 was 
maintained: 352; Projected FTEs as a percentage of those planned: 128.

Priority area: Other abusive schemes worked by tax compliance officers; 
Planned FTEs: 34; Projected FTEs if the pace at July 31, 2003 was 
maintained: 17; Projected FTEs as a percentage of those planned: 51.

Priority area: Total; Planned FTEs: 1,020; Projected FTEs if the 
pace at July 31, 2003 was maintained: 470; Projected FTEs as a 
percentage of those planned: 46.

Source: IRS data compiled by GAO.

[End of table]

Other data illustrate how difficult it is for IRS to reliably estimate 
the resources that may be needed to work abusive schemes due to 
uncertainty about the volume of cases that it will need to examine and 
the rate at which IRS will be able to close examinations. The data 
indicate that, at times, the actual number of cases identified and the 
rate at which cases were being closed diverged significantly from the 
estimates used to plan for fiscal year 2003 FTEs. For example, as shown 
in table 5, by July 31, 2003, SB/SE did not yet have offshore credit 
card cases lined up for examination that would approach the number the 
budget was intended to cover, and it had closed only 18 percent of the 
cases it had anticipated closing. On the other hand, SB/SE had more 
cases involving other abusive schemes in its queue for revenue agents 
to handle than it had estimated it could work in fiscal year 2003, but 
it was closing almost twice as many cases as expected. Having budgeted 
FTEs to work 9,060 complete cases involving other abusive schemes, it 
had enough resources to begin and/or complete work in fiscal year 2003 
on many of the 20,810 cases it identified by July 31, 2003. It could 
complete many of the unfinished cases in fiscal year 2004, and by that 
time, have identified new cases to work.

Table 5: Comparisons of Inventory Developments with Inventory 
Expectations:

Priority area: Promoters; Number of cases identified by July 31, 
2003[A]: 535; Number of equivalent cases SB/SE estimated it could 
cover in FY 2003: 569; Rate at which cases expected to be closed by 
July 31, 2003 actually were closed by that time: Not available.

Priority area: Offshore credit card schemes; Number of cases identified 
by July 31, 2003[A]: 2,208[B]; Number of equivalent cases SB/SE 
estimated it could cover in FY 2003: 9,455; Rate at which cases 
expected to be closed by July 31, 2003 actually were closed by that 
time: 18%.

Priority area: Other abusive schemes worked by revenue agents; Number 
of cases identified by July 31, 2003[A]: 20,810; Number of equivalent 
cases SB/SE estimated it could cover in FY 2003: 9,060; Rate at which 
cases expected to be closed by July 31, 2003 actually were closed by 
that time: 193%.

Priority area: Other abusive schemes worked by tax compliance officers; 
Number of cases identified by July 31, 2003[A]: 2,607; Number of 
equivalent cases SB/SE estimated it could cover in FY 2003: 4,570; Rate 
at which cases expected to be closed by July 31, 2003 actually were 
closed by that time: 44%.

Source: Calculated by GAO from IRS data.

[A] This calculation entailed adding the number of cases that either 
started in fiscal year 2003 or were identified to be started but had 
not yet begun by July 31, 2003. To this total, we added cases carried 
over from fiscal year 2002 into 2003, but adjusted the total to reflect 
that a portion of the casework had been completed. For example, if two 
cases carried into 2003 were half completed, we counted them as one 
case. We relied on IRS estimates of case status to make these 
adjustments. The resulting totals do not represent cases that IRS could 
necessarily complete in fiscal year 2003 because, we were told, many 
cases could take 2 or 3 years.

[B] SB/SE officials explained that over time IRS would identify 
additional tax returns related to the 2,208 offshore credit card cases 
that had been identified as of July 31, 2003. SB/SE projected that each 
offshore credit card case originally identified would eventually 
include four tax returns, on average.

[End of table]

SB/SE officials told us that they accommodated shortfalls in cases or 
in budgeted examination resources by shifting examination FTEs among 
different types of abusive scheme examinations and to other priority 
programs. According to them, the offshore credit card cases did not 
start as quickly as anticipated because dealing with the summons 
process took longer than expected. However, this delay allowed more SB/
SE resources to be used for other abusive schemes.

Although to date SB/SE officials have acted to accommodate unexpected 
differences in the volume of cases and the time needed to work them, 
uncertainties affecting future resource levels are perhaps even 
greater. There is the potential that the volume of cases could grow 
significantly, but it is not clear how much the caseload will grow or 
how quickly. For example, in the offshore credit card scheme area, IRS 
has not yet assessed how many new cases may be identified from the 214 
new offshore promoters found in its voluntary compliance initiative 
that closed on April 15, 2003. Also, by early August 2003, IRS had 
received records from its second round of credit card summonses, which 
covered credit card company records on cards issued by banks in 31 
offshore financial centers. Efforts like these may potentially expand 
the caseload but by an unknown amount.

To the extent the potential cases expand, IRS's experience so far, as 
alluded to earlier, has been that it is taking longer than originally 
expected to obtain all of the information needed to actually identify 
individuals for potential examination and to make informed choices 
about which cases merit examination. IRS found, for example, that the 
information from credit card summonses often was insufficient to 
identify individuals, and, therefore, it had to issue summonses to 
merchants as well to obtain identifying information. Therefore, IRS 
would be more likely to be able to handle the examination caseload if 
the universe of potential examination cases expands, even fairly 
significantly, but developing those cases to the point they can 
actually be examined stretches out over time, than if a "workable" 
caseload materializes quickly.

The fiscal year 2003 statistics in table 5 also illustrate that the 
rate at which identified cases may be closed is highly uncertain. 
According to an SB/SE official, SB/SE took its time estimates for 
working on abusive scheme cases from its most complex abusive case 
examinations. SB/SE officials explained that IRS had very little 
history to use in estimating the time needed to process promoter, 
offshore credit card, and other abusive scheme cases. The matrix being 
developed in fiscal year 2003 was designed to collect information that 
will help executives assess resources needed. As SB/SE gains experience 
with current cases, officials said, the planning process would become 
more refined.

Across the spectrum of IRS's responsibilities, IRS works varying 
amounts of the identified workload. It has pointed to gaps between what 
it should be doing and what it has the capacity to do in areas ranging 
from individuals to small and large corporations. IRS will make future 
decisions about the portion of abusive scheme cases that it will work 
as part of its overall processes for allocating resources among its 
many competing priorities.

We have previously raised questions about IRS's ability to shift 
compliance resources as planned. We recently testified that many 
parties have expressed concern about declining IRS compliance--
especially audit--and collection trends for their potential to 
undermine taxpayers' motivation to fulfill their tax 
obligations.[Footnote 6] Concerned about these trends, IRS has sought 
more resources, including increased staffing for compliance and 
collections, since fiscal year 2001. Despite receiving requested budget 
increases, staffing levels in key occupations were lower in 2002 than 
in 2000. These declines occurred for reasons such as unbudgeted 
expenses consuming budget increases and other operational workload 
increases.

Conclusions:

Having designated abusive schemes as a priority enforcement area, IRS 
has made progress in developing an agencywide effort to address 
schemes. To ensure that these efforts are focused and to support both 
congressional and IRS assessments of progress in combating abusive 
schemes, IRS officials must follow through on their intention to 
develop long-term process and results-oriented performance goals and 
associated measures.

Fiscal year 2003 experience, however, illustrates that IRS likely will 
need to continually adjust its efforts. Although IRS identified many 
more of some types of abusive schemes than it expected it could handle 
in fiscal year 2003, the development of a workable inventory of 
offshore credit card scheme cases progressed much more slowly than 
anticipated. On balance, this likely led to IRS using substantially 
fewer resources for abusive scheme work in fiscal year 2003 than 
anticipated. As with developing long-term goals and measures, officials 
recognize that they must build a better analytic basis for judging the 
appropriate resources to assign to pursuing abusive schemes and intend 
to do so as they better identify the potential workload and how quickly 
they can close cases. Given that abusive schemes are a top priority for 
IRS and have been the focus of congressional attention, the potential 
size of the problem is a key reference point for policymakers in 
judging whether IRS has appropriate resources and an effective strategy 
over time for combating the schemes. Although estimating the potential 
size of the problem is inherently difficult and must rely on 
assumptions and officials' judgment, documenting the basis for the 
estimates can help others judge how to interpret the numbers and use 
them to make decisions.

Recommendation to the Commissioner of Internal Revenue:

We recommend that the Commissioner of Internal Revenue document the 
support underlying future IRS estimates of the size of the abusive 
scheme problem when IRS prepares the estimates.

Agency Comments:

In written comments, the Commissioner of Internal Revenue agreed with a 
draft of this report. He specifically agreed with the recommendation 
and said that IRS would establish a methodology for documenting the 
basis for the estimates. He noted that the other information we 
provided would also help IRS improve its abusive scheme program for 
fiscal year 2004 and beyond. In addition, he affirmed IRS's intention 
to establish measurable process and results-oriented goals and said 
that developing these measures is an operational priority for fiscal 
year 2004.

The Commissioner also provided other general comments on our draft 
report and an update of activities since the time of our review. For 
instance, he said that as a result of LDC improvements, expedited 
procedures with the Department of Justice, and many other efforts, IRS 
recently identified significant numbers of abusive scheme promoters and 
participants and refined its methods to deal with them. In addition, he 
noted, a key part of the ongoing, infrastructure-building efforts that 
we describe was forming and training 12 cross-functional teams in 2003 
to identify traditional or alternative strategies for addressing 
individual schemes. Also, he stated that, as of October 2003, 42 states 
and the District of Columbia had signed a memorandum of understanding 
focusing on exchanging information with IRS relating to abusive tax 
avoidance transactions. Finally, he pointed out that given IRS's 
inability in 2003 to consistently identify and deliver abusive scheme 
cases to be worked in IRS field offices, IRS policy is to focus on 
other strategic priorities when it does not have an abusive scheme case 
to work.

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

As agreed, unless you publicly announce its contents earlier, we plan 
no further distribution of this report until 30 days from the date of 
the report. At that time, we will send copies to the Commissioner of 
Internal Revenue, the Secretary of the Treasury, and other interested 
parties. The report will also be available at no charge on GAO's Web 
site at [Hyperlink, http://www.gao.gov] http://www.gao.gov.

If you or your staff have any questions about this report, please 
contact Signora May on (404) 679-1920 or me on (202) 512-9110. Melissa 
Hinton and Lawrence Korb were key contributors to this report.

Signed by: 

Michael Brostek: 
Director, Tax Issues:

[End of section]

Appendixes: 

Appendix I: Comments from the Internal Revenue Service:

COMMISSIONER:

DEPARTMENT OF THE TREASURY 
INTERNAL REVENUE SERVICE 
WASHINGTON, D.C. 20224:

November 12, 2003:

Mr. Michael Brostek: 
Director, Tax Issues: 
United States General Accounting Office 
Washington, D.C. 20548:

Dear Mr. Brostek:

I reviewed your draft report entitled, "Challenges Remain in Combating 
Abusive Tax Schemes" (GAO-04-05). We agree with your recommendation 
that we need to document the basis for the underlying estimates of the 
Abusive Scheme problem and will establish a methodology to do so. The 
other information you provided will also help us improve the program 
for FY 2004 and beyond. In addition to providing general comments on 
your report, we would also like to give you an update on relevant 
activities since the date of your audit.

As the report acknowledges, we are making strides in our ability to 
identify abusive scheme promoters as well as their participants. Given 
the magnitude of the scheme problem today - that there are over 400,000 
taxpayers involved and billions of dollars potentially escaping 
taxation, we are focused on meeting the challenges raised in your 
report. Our Lead Development Center continues to improve its 
investigation methods as well as reducing its cycle time for processing 
these cases. We have also developed integrated approaches with other 
divisions as well as expedited procedures with the Department of 
Justice. As a result of these and many other efforts, we have 
identified significant numbers of promoters and participants since your 
audit, as well as refined our methods to deal with them.

Your report also recognizes our ongoing efforts to build an 
infrastructure to address abusive schemes. One key step was the 
formation of issue management teams. In 2003, we formed and trained 
twelve teams, each headed by an executive or territory manager. These 
teams are charged with identifying an overall strategy for their 
assigned issue or scheme. Strategies may include traditional approaches 
such as examination or alternative resolution strategies which may 
resolve large numbers of taxpayer cases more quickly. Team members 
include representatives from Small Business/Self-Employed (SB/SE) 
Compliance and Taxpayer Education and Communication (TEC) offices and 
SBSE Division Counsel. When appropriate, other operating units such as 
Large and Mid-Size Business (LMSB), Tax Exempt/Government Entities (TE/
GE) and Criminal Investigation participate.

In September 2003, we announced the establishment of a nationwide 
partnership to combat abusive tax avoidance. Under agreements with 
individual states, the IRS will share information on abusive tax 
avoidance transactions and those taxpayers who participate in them. The 
agreements creating this partnership are designed to enable States and 
the IRS to move more aggressively in addressing this tax compliance 
problem. As of October 2003, 42 states and the District of Columbia 
have signed the Memorandum of Understanding focusing on the exchange of 
information relating solely to abusive tax avoidance transactions. The 
partnership also includes joint public outreach activities to more 
effectively counter the claims of those marketing tax schemes and 
scams.

As pointed out in your report, we began shifting examination resources 
to support our strategic priorities in FY 2003. 2003 was a transition 
year, because we did not have an established inventory selection and 
delivery system for the new type of work our strategies required. Our 
work plan had to rely on limited data given that we had not done this 
type of work previously to any great extent. As a consequence we over-
estimated our ability to deliver inventory to the field. While the 
total planned Full Time Equivalents for the Abusive Schemes Program 
were not delivered, we used the resources for other priority work, such 
as the Unreported Income Discriminate Function Program. Given the 
inability in 2003 to identify and deliver abusive scheme inventory 
consistently, our policy is to focus on other strategic priorities if 
we do not have an abusive scheme case to work.

We will establish measurable program goals during Fiscal Year 2004 
which will be process and results-oriented. The FY 2004 Business Plan 
includes the development of these measures as an operational priority.

We believe we are making progress combating these pervasive attacks 
against our tax administration system. We are: (1) better warning 
taxpayers about the dangers of the schemes and scams; (2) better 
identifying the promoters and participants in them;

(3) using our enforcement powers more effectively; (4) better 
coordinating our actions with the Justice Department to shut down the 
schemes before they do more damage; (5) bringing taxpayers back into 
compliance; and, (6) helping to restore public confidence in the 
fairness of our tax administration system.

If you have any questions, please contact me or Joseph R. Brimacombe, 
Deputy Director, Compliance Policy, at (202) 283-2200.

Sincerely,

Signed for: 

Mark W. Everson:

[End of section]

(450226):

FOOTNOTES

[1] U.S. General Accounting Office, Internal Revenue Service: Enhanced 
Efforts to Combat Abusive Tax Schemes--Challenges Remain, GAO-02-618T 
(Washington, D.C.: Apr. 11, 2002).

[2] P.L. 103-62.

[3] Guidance related to GPRA can provide a framework in developing 
measurable goals and outcome-oriented measures. Although GPRA is 
generally applied to agencywide strategic plans, its framework is 
useful to guide any type of planning. GPRA requires long-term strategic 
and annual performance goals and associated measures, preferring 
measures relating to outcomes (results) versus outputs (activities). 
Office of Management and Budget guidance says that strategic plans set 
out long-term goals, outlining planned accomplishments and their 
implementation schedule.

[4] Between November 2001 and November 2002, Treasury entered into 
agreements with the Cayman Islands, Antigua and Barbuda, The Bahamas, 
the British Virgin Islands, the Netherlands Antilles, Guernsey, the 
Isle of Man, and Jersey.

[5] Nonabusive flow-through entities are entities such as trusts and 
partnerships that IRS examines as part of its broad coverage of 
taxpayers, even though it has no specific reason to think they are 
abusive.

[6] U.S. General Accounting Office, Compliance and Collection: 
Challenges for IRS in Reversing Trends and Implementing New 
Initiatives, GAO-03-732T (Washington, D.C.: May 7, 2003).

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The first copy of each printed report is free. Additional copies are $2 
each. A check or money order should be made out to the Superintendent 
of Documents. GAO also accepts VISA and Mastercard. Orders for 100 or 
more copies mailed to a single address are discounted 25 percent. 
Orders should be sent to:

U.S. General Accounting Office

441 G Street NW,

Room LM Washington,

D.C. 20548:

To order by Phone:  

 Voice: (202) 512-6000:

 TDD: (202) 512-2537:

 Fax: (202) 512-6061:

To Report Fraud, Waste, and Abuse in Federal Programs:

Contact:

Web site: www.gao.gov/fraudnet/fraudnet.htm E-mail: fraudnet@gao.gov

Automated answering system: (800) 424-5454 or (202) 512-7470:

Public Affairs:

Jeff Nelligan, managing director, NelliganJ@gao.gov (202) 512-4800 U.S.

General Accounting Office, 441 G Street NW, Room 7149 Washington, D.C.

20548: