The problem of abusive tax avoidance transactions is constantly changing, and the Internal Revenue Service needs better information to stay on top of it, according to a new government report.
The report, by the Government Accountability Office, covered abusive tax avoidance transactions, or ATATs, ranging from frivolous tax schemes to highly technical and abusive tax shelters marketed to taxpayers by promoters selling tax advice. The GAO noted that the schemes threaten the U.S. tax system’s integrity if honest taxpayers believe that others do not pay their fair share of taxes.
The IRS and the Justice Department have been working together to prosecute the promoters of tax shelter schemes, as in the recent case of Quellos Group (see Lawyer Sentenced in Quellos Tax Shelter Scheme). Some Big Four accounting firms have also found themselves in court in recent years accused of promoting tax shelters to clients.
However, the available data on the tax avoidance transactions is still limited. The GAO report found that while trend data on taxpayers' use of ATATs are limited, the IRS and other experts that the GAO contacted agreed that a problem exists and is continually changing.
One theme that emerged from the GAO's discussions with these experts is that ATATs marketed by promoters to corporations and wealthy individuals have declined in recent years, although the experts had different views on the extent of the decline. They also said that ATATs have become more international in nature.
Even though estimating the extent of the ATAT problem is inexact because ATATs are often hidden, the experts believed that the changing nature of ATATs warrants continuous IRS vigilance. The IRS has many ATAT-related enforcement efforts—including investigations, examinations, and settlement initiatives—across different divisions but has incomplete data on the results on those efforts.
For example, promoter investigations by the IRS's small business division help stop promotions, but the IRS had incomplete information on why investigations were often closed without penalties or injunctions. Such information could be used to help decide the types of investigations to start, the GAO observed.
In addition, the IRS recommended billions of dollars in additional taxes from examining tax returns with suspected ATATs, but the IRS did not identify the part of the additional amount that was collected or that related to the ATAT issue, as opposed to other issues. In addition, some ATAT results were reported inconsistently across different IRS divisions. Without comprehensive or consistent information, the IRS does not have the best information to decide which promoters to investigate and the number of examinations that should be done as well as to evaluate their impacts.
Even though a 2004 law increased the requirements for taxpayers and promoters to disclose their use of transactions and enhanced the penalties for improper disclosure, problems still remain. The IRS received many disclosures of transaction use from taxpayers, but it had no assurance that its Office of Tax Shelter Analysis received all the disclosures it should have.
In addition, the IRS did not verify that all the disclosures it received were complete, and a new process for reviewing the completeness of disclosures and following up with taxpayers was not yet finalized. Not receiving disclosures, or receiving incomplete disclosures of transactions, would keep the IRS from having the information it needs to identify the transactions that merit an examination of their appropriateness and to assess related penalties as needed, the GAO noted.
Finally, while certain promoters who are required by law under threat of penalty to give their list of investors within 20 business days after the IRS requested it did so, other promoters who are not covered by this requirement often took longer than 20 days to provide the lists without the threat of a similar penalty. The IRS did not comprehensively track how quickly the lists were received. Not receiving lists on a timely basis prevents the IRS from quickly working to stop promoter activity, the GAO noted.
The GAO suggested that Congress consider instituting a penalty aimed at certain promoters not giving investor lists to IRS within a specified time. The GAO also recommended that the IRS act or establish processes to improve data on the results of ATAT-related investigations and examinations, ensure that required disclosures are filed by taxpayers, review disclosures for completeness; track the time for the IRS to receive investor lists; and induce more promoters to provide investor lists by a specified time.
In commenting on a draft of the GAO report, the IRS agreed with most recommendations but cited resource and capability constraints in tracking ATAT data and investor lists, which GAO believes can be addressed.
“The IRS agrees that better data may lead to better decisions about focusing resource allocations and improve our enforcement efforts for Abusive Tax Avoidance Transactions,” wrote IRS deputy commissioner for services and enforcement Steven T. Miller.
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