Feeble audit procedures are allowing tax cheats to evade billions of dollars in U.S. tax liabilities each year by hiding funds in offshore accounts, government investigators told Congress.
"Offshore tax evasion has become a large and growing element of the tax gap, and the IRS is increasingly outgunned in its effort to enforce tax rules in the international economy," Senate Finance Committee chair Max Baucus, D-Mont., said at the kickoff of hearings on Capitol Hill into the problem.
"An estimated $300 billion is transferred out of the U.S. to foreign accounts each year, and we're told that the Internal Revenue Service has no idea where $19 billion [of that] ends up, once the funds are transferred overseas," Baucus said. "This is troubling."
The chairman heard more unnerving testimony from the star witness at those hearings, Government Accountability Office strategic issues director Michael Brostek, who suggested that the U.S. tax bureaucracy deserves a significant share of the blame for those lost monies.
Although the IRS lacks legal authority to directly audit a foreign financial intermediary, the service does encourage foreign banks and other offshore financial service providers to cooperate with U.S. tax authorities by voluntarily serving as qualified intermediaries, or QIs.
These QIs must contract with external auditors who perform periodic procedures to determine whether the participating foreign banks are documenting customers' identities and accurately withholding and reporting to the IRS.
But instead of insisting on a full audit, including both the scope of work and the nature of the auditor's conclusions, the IRS requires only that QIs secure an outside auditor to perform agreed-upon procedures - a process that stops well short of the rigorous audit requirements imposed on U.S. companies.
"A major problem with this is that QIs' auditors are not responsible for following up on possible indications of fraud or illegal acts that could have an impact on the matters being tested, as they would under U.S. government auditing standards," Brostek told lawmakers.
Worse yet, Brostek suggested that the IRS is shirking its own oversight responsibilities with respect to offshore financial reporting. "The tax service obtains considerable data from withholding agents, but does not make effective use of the data to ensure that withholding agents perform their duties properly," he said.
Brostek told the committee that much of the data that the IRS needs to police the QI program is not readily available for use, and some of it no longer exists at all. "As a result, the IRS has difficulty ensuring that refunds claimed by withholding agents are accurate, and is less able to effectively target its enforcement action," he said.
WHAT'S BEEN LOST?
Exactly how much revenue is slipping through the cracks due to offshore tax chiseling is a mystery to the IRS, but witnesses at the Senate hearings suggested that the total could be enormous.
The $300 billion that the GAO estimated is transferred to offshore accounts is only a starting point for determining the magnitude of the problem, Baucus said, adding that the real amount transferred overseas is much higher.
Noting that the return to the IRS from an offshore case is typically three times what is recovered from a domestic case, the Montana Democrat said, "This is a sure sign that the volume of offshore tax evasion
Another expert at the hearing, University of Michigan Law School Professor Reuven S. Avi-Yonah, called offshore tax avoidance "a significant component of the overall tax gap."
The tax gap, the difference between taxes owed and taxes paid, was estimated at $290 billion for 2001 - a compliance rate of about 86 percent.
Indeed, Avi-Yonah said, the losses to the Treasury from offshore tax evasion "may, in fact, be larger than some components that have attracted more public and IRS attention, like corporate tax shelters or Earned Income Tax Credit fraud."
For his part, the committee's ranking Republican, Sen. Chuck Grassley of Iowa, said that Internet tax-shelter hustlers may be enticing more taxpayers to try to avoid their tax liabilities by transferring funds abroad.
"Since 1913, our tax code has subjected U.S. citizens to income tax on their worldwide income," Grassley said. "No matter what the Internet purveyors of tax evasion say, this principle cannot be avoided by living on a yacht or putting passive assets and income offshore."
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