Businesses that have developed complex networks of related trusts and partnerships to evade taxes are making it difficult for the Internal Revenue Services efforts to close the tax gap, according to a new government report.
The IRS views network-based tax evasion as a problem but does not have estimates of the associated revenue loss, in part because data does not exist on the full population of the networks, according to a report by the Government Accountability Office. 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 IRS to identify.
The IRS does know that at least 1 million networks existed involving partnerships and similar entities in tax year 2008. The IRS also knows that many questionable tax shelters and abusive transactions rely on the links among commonly owned entities in a network, said the report.
The IRS generally addresses network-related tax evasion through its examination 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, the report noted. 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.
In reaction to the report, Senate Finance Committee Chairman Max Baucus, D-Mont., called for new tools to help the IRS fight complex tax evasion schemes. Baucus had requested the report from the GAO as part of his ongoing efforts to reduce the estimated $345 billion tax gap.
When people skirt their tax obligations, it places an undue burden on the hardworking Americans who do pay their taxes, said Baucus in a statement. This report makes clear the IRS needs to develop a comprehensive strategy to fight complex tax evasion schemes and that more work is needed to close the tax gap. I intend to closely monitor the IRSs progress to make sure they have an effective strategy to root out this tax evasion and close the tax gap once and for all.
The 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 when compared to the GAO's criteria for assessing network analyses. 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, the IRS has no agency-wide strategy or goals for coordinating its network efforts. It has not conducted assessments of its network tools, nor has it determined the value of incorporating more data into its network programs and tools or scheduled such additions. Without a strategy and assessments, the 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, said the report.
Among other items, the GAO recommends that the IRS establish an IRS-wide strategy that coordinates its network tax evasion efforts. Also, the IRS should assess its network programs and tools and should evaluate adding more data to its current tools. The IRS generally agreed with these recommendations and noted additional organizational changes the agency is making that will address networks.
In the end, the IRS will always be challenged to find technological, administrative, or auditing approaches to address the tax problems associated with the ever-increasing complexity and variability of both legitimate and abusive entity structures that use tiered flow-through tax reporting, wrote IRS Deputy Commissioner Steven T. Miller. We are in the process of studying potential legislative and guidance changes to reduce the tax risks inherent in network structures.
Register or login for access to this item and much more
All Accounting Today content is archived after seven days.
Community members receive:
- All recent and archived articles
- Conference offers and updates
- A full menu of enewsletter options
- Web seminars, white papers, ebooks
Already have an account? Log In
Don't have an account? Register for Free Unlimited Access