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 schemessuch as the one described in the text box belowresult 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.
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.
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 toolsneither 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.
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.
The information contained in this analysis is based on the related GAO product listed under the "Related GAO Products" tab.
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A taxpayer can control a group of related entities--such as trusts, corporations, or partnerships--in a network. These networks can serve a variety of legitimate business purposes, but they also can be used in complex tax evasion schemes that are difficult for the Internal Revenue Service (IRS) to identify. GAO was asked to (1) describe what IRS knows about network tax evasion and how well IRS's t...
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