by Roger Russell

At a time when many states are hurting for revenue, the Internal Revenue Service has started sharing leads on more than 20,000 taxpayers engaged in abusive tax avoidance with tax agencies in 46 states, the District of Columbia and New York City.

The initial leads that were transferred to states involved scams using offshore transactions, abusive trusts, employee leasing, home-based businesses, employment taxes and other tax-avoidance schemes.

“Both the states and the federal government are looking for more revenue,” said George Farrah, director of state services for BNA Tax Management. “Taxpayers have become so aggressive in their avoidance schemes that there’s a public outcry. They’re trying to get away with a little too much, and with Enron still in the background, people are sensitive to individual and corporate piggishness.”

The four states not currently participating are Michigan, Nevada, Texas and Wyoming.

“At the same time, they’re using it as a deterrent,” Farrah said. “They’re promoting it as a ‘You’d better watch out, we’re coming after you’ measure.”

“Efforts like this allow all of us to leverage our resources and avoid duplicate exams, and share results,” said Steven Burgess, acting director of reporting enforcement of the Small Business, Self-Employed Division of the IRS. “It drastically increases the enforcement resources available around these issues.”

The IRS said that it would share more information with states and cities on any resulting tax adjustments from the audits, allowing them to piggyback on the results of each other’s work. The process will allow the agencies to leverage resources by decreasing the possibility of two or even three agencies performing a lengthy examination of the same taxpayers, according to the IRS.

For returns that go beyond the straight Form 1040, preparers should beware of any client transactions that don’t look completely above board, observers said.

“Practitioners should beware of audits now on the state level,” said George Jones, managing editor of CCH’s Washington office. “They will be a lot more sophisticated in their work on tax shelters. The states are looking for revenue, so there’s the incentive for them to press forward very aggressively.”

“The IRS’s whole interest in this partnership is that they’re trying to maximize their own resources. They’ve put out a lot of rules now and the focus will be on enforcing the rules in the next few years. That’s going to be a lot more difficult than making the rules,” Jones added.

The sharing of leads is the first large transfer of information under the terms of the IRS-state partnership agreement unveiled in September 2003. More than 20,000 audit leads and other information have been shared with the states, and more information will be shared in the future, according to IRS officials.

“The information being shared seems to have gone further than what the accounting community initially thought,” said Jeffrey Pretsfelder, CPA, managing editor at RIA, a Thomson business. “When they announced it last year, it seemed primarily aimed at high-level and offshore abuse. But now they’ve included such things as home-based businesses. It could hit people that we initially thought wouldn’t be affected.”

Under the terms of the partnership, the IRS and the states coordinate efforts to address common compliance concerns in the area of abusive tax avoidance transactions by working in tandem and avoiding repeating each other’s efforts.

“The states and the IRS routinely share information, but the ATAT program presents us with an exceptionally fertile opportunity to help one another,” said Stephen M. Cordi, deputy comptroller for Maryland and president of the Federation of Tax Administrators, an association of the tax agencies in all states, D.C. and New York City.

“These abusive shelters are hidden through many layers of business transactions and money shifts,” he continued. “Each agency may have a few pieces of that puzzle, but by working together we can fit it all together for the benefit of taxpayers.”

Farrah agreed. “These transactions are very complicated and it takes a lot of work just to understand what’s going on. If the IRS and the states can work together to unravel these things, there’s a better chance they’ll figure it out.”

Code Section 6103(d) requires a written request for a state to get information from the IRS. The agreement between the IRS and the states constitutes this written request, according to Farrah, so the states don’t have to ask individually.

“The agreement is specifically aimed at these abusive transactions,” said Farrah. “Traditionally, if you get audited and the IRS says you have $10,000 more in income, and you agree and pay the tax, the IRS would report it to your state and the state could assess. In that case the IRS is just reporting information from the tax return. In this case, they’re sharing all types of information, including training material, strategy and procedures.”

“But the biggest reason for the agreement is the fact that the transactions are so complicated, and they all need to work together to understand what’s going on,” he said.

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