Skip to Highlights
Highlights

Recently, concerns have arisen about the use of certain financial derivatives to avoid or evade tax obligations. As requested, this report (1) identifies and evaluates how financial derivatives can be used to avoid or evade tax liability or achieve differing tax results in economically similar situations, (2) evaluates Internal Revenue Service (IRS) actions to address the tax effects of investments in financial derivatives through guidance, and (3) evaluates IRS actions to identify financial derivative products and trends through information from other agencies. GAO reviewed research and IRS documents and interviewed IRS and, Department of the Treasury (Treasury) officials and other experts. GAO analyzed the completion of financial derivative projects on the agencies' Priority Guidance Plans (PGP) from 1996 to 2010.

Skip to Recommendations

Recommendations

Recommendations for Executive Action

Agency Affected Recommendation Status
Department of the Treasury To better ensure that economically similar outcomes are taxed similarly and minimize opportunities for abuse, the Secretary of the Treasury should undertake a study that compares the current approach to alternative approaches for the taxation of financial derivatives. To determine if changes would be beneficial, such a study should weigh the tradeoffs to IRS and taxpayers that each alternative presents, including simplicity, administrability, and economic efficiency.
Open
Treasury disagreed with this recommendation based on the fact that many outside studies already exist and IRS did not comment. The Tax Cuts and Jobs Act enacted in December 2017 did not include any requirements that Treasury study alternative approaches for the taxation of financial derivatives. However, members of Congress in the 117th have discussed a mark-to-market tax system, which would include financial derivatives. GAO continues to maintain that further study is needed in coordination with IRS and will continue to monitor the climate for such a study.
Department of the Treasury To provide more useful and timely information to taxpayers on the status of financial derivative guidance projects, the Secretary of the Treasury and the Commissioner of Internal Revenue should consider additional, more frequently updated reporting to the public on ongoing projects listed in the PGP, including project status, changes in priorities, and target completion dates both within and beyond the 12-month PGP period.
Closed - Not Implemented
IRS and Treasury disagreed with this recommendation, citing the difficulty of estimating completion dates. GAO still maintains that taxpayers would benefit from additional information on financial derivative Priority Guidance Plan (PGP) projects and that dates can be estimated. Some changes have been made with the PGP but project status, changes in priorities, and target completion dates are still not included.
Department of the Treasury To more quickly identify new financial derivative products and emerging tax issues, IRS should work to improve information-sharing partnerships with SEC and CFTC to better ensure that IRS is fully using all available information to identify and address compliance issues and abuses related to the latest financial derivative product innovations. IRS should also consider exploring whether such partnerships with bank regulatory agencies would be beneficial.
Closed - Implemented
During our review of the use of certain financial derivatives to avoid or evade tax obligations, we evaluated the Internal Revenue Service's (IRS) actions to identify new financial derivative products and emerging tax issues through information from other federal agencies. We recommended that IRS work to improve information-sharing partnerships with the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) to better ensure that IRS is fully using all available information to identify and address compliance issues and abuses related to the latest financial derivative product innovations. We also recommended that IRS should also consider exploring whether such partnerships with bank regulatory agencies would be beneficial. In April 2012, IRS told us that they had begun work to initiate the information sharing relationships in response to our recommendation and were considering ways to improve information sharing partnerships with SEC and CFTC regarding financial derivatives, particularly in the area of new products. IRS told us that they were also considering whether partnerships with other federal regulatory agencies would be beneficial. IRS officials met with SEC, CFTC and other bank regulatory agencies in March 2012 and May 2012 to evaluate information sharing possibilities and joint collaboration. Two meetings were held in March 2012 to discuss existing projects and ways to leverage SEC and CFTC expertise about financial derivatives. On May 11, 2012, IRS officials from the LB&I Financial Services, PFTG, LB&I Division Counsel, and the Office of Associate Chief Financial Institutions and Products met in person with officials from the OCC, FDIC, and Federal Reserve to share information and discuss current tax issues that relate to financial transactions in the banking industry, specifically debt losses from the 2008 market downturn. IRS officials plan to reach out to CFTC in the future. As a result of these meetings, as of January 4, 2013, IRS LB&I Financial Services/Financial Products had evaluated and initiated information sharing relationships with SEC, CFTC and other regulatory agencies. IRS told us that they intend to continue the information sharing meetings in the future.

Full Report