Tax Gap:

IRS Can Improve Efforts to Address Tax Evasion by Networks of Businesses and Related Entities

GAO-10-968: Published: Sep 24, 2010. Publicly Released: Oct 25, 2010.


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    This video illustrates how a tax evasion scheme called an installment bogus optional basis transaction (iBOB) works.

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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 Internal Revenue Service (IRS) to identify. GAO was asked to (1) describe what IRS knows about network tax evasion and how well IRS's traditional enforcement programs address it and (2) assess IRS's progress in addressing network tax evasion and opportunities, if any, for making further progress. To do this, GAO reviewed relevant documentation about IRS programs and interviewed appropriate officials about those programs and IRS's plans for addressing such tax evasion. GAO also interviewed relevant experts and agency officials in developing criteria needed to perform the assessment.

IRS views network-based tax evasion as a problem but does not have estimates of the associated revenue loss in part because data do not exist on the population of networks. IRS does know that at least 1 million networks existed involving partnerships and similar entities in tax year 2008. IRS also knows that many questionable tax shelters and abusive transactions rely on the links among commonly owned entities in a network. 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. 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. 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 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, IRS has no agencywide 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, 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. Among other items, GAO recommends that IRS establish an IRS-wide strategy that coordinates its network tax evasion efforts. Also, IRS should assess its network programs and tools and should evaluate adding more data to its current tools. IRS generally agreed with these recommendations and noted additional organizational changes the agency is making that will address networks.

Recommendations for Executive Action

  1. Status: Open

    Comments: In a follow-up report on the recommendations, IRS agreed that a need exists to address network noncompliance more strategically. However, the agency still does not have a documented strategy for addressing network noncompliance that covers the four areas listed in the recommendation. Officials said that one may yet be done but did not provide a timetable for doing so. Instead, the agency is making iterative efforts to improve programs and tools--such as yK-1, Graph Query and Enterprise Graph--that touch on network noncompliance as well as aspects of our recommendation such as assessing effectiveness and adding more data; however, these efforts are not yet strategic or IRS-wide. As part of that effort, IRS conducted a user survey of its network analysis tool, yK-1, in 2011. Part of the survey process included getting user feedback for better training. IRS had plans in its 2011 budget for the creation of the Advanced Research Center, a program that would focus on the detection of schemes and other abusive transactions. Benefits IRS cited from the proposed center included: allowing IRS to identify abusive transactions and emerging trends, promoting collaboration for cases that cross operating divisions, developing and using a suite of tools for addressing abusive transactions, and centralizing datasets into a cohesive data sharing strategy. However, the Advanced Research Center program was not funded. As of January 2015, we continue to monitor IRS's progress on this recommendation.

    Recommendation: The Commissioner of Internal Revenue should establish an IRS-wide strategy with goals, which may need to be developed incrementally, to coordinate and plan ongoing and future efforts to identify and pursue network tax evasion. The strategy should include: (1) assessing the effectiveness of network analysis tools, such as yK-1; (2) determining the feasibility and benefits of increasing access to existing IRS data, such as scanning additional data from Schedule K-1, or collecting additional data for use in its network analysis efforts; (3) putting the development of analytical techniques and tools that focus on networks as the unit of analysis, such as GraphQuery, on a specific time schedule; and (4) deciding how network efforts will be managed across IRS, such as whether a core program team or management group is needed.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Closed - Implemented

    Comments: In a follow-up report to the recommendations, IRS officials said that earlier this year, they completed an annual survey of staff using yK-1, a network analysis tool. The survey included new questions on developing a better understanding of how users interact with yK-1 and what kinds of improvements could be made to the tool and instruction on using it. These questions were added specifically in response to GAO's report. As a result of the survey, IRS made adjustments to job aides for users. For example, the office responsible for developing the survey and the yK-1 tool added an index to an existing yK-1 users' manual. Officials also reported adding updated information to training programs for new staff using yK-1. IRS officials said that it intends to continue making updates based on its annual survey. IRS does not have a documented plan for doing so but said they are committed to continuing the survey.

    Recommendation: The Commissioner of Internal Revenue should ensure that staff members who will be using current and additional network tools fully understand the tools' capabilities.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Closed - Implemented

    Comments: In a follow-up report on the recommendations, IRS officials said that it has not created a formal mechanism for programmers and front-line users to interact. However, IRS officials said they completed an annual survey of staff during 2011 on using yK-1, a network analysis tool. After the survey, IRS also held feedback sessions between programmers and users of the tool. During these discussions, participants discussed ways to make the yK-1 tool more effective. Officials representing the Large Business and Internal division, which is a user of yK-1, said they were satisfied with the way the feedback loop operated. IRS does not maintain a formal timetable for when these interactions must occur but said will continue to conduct them as part of their annual network analysis tool survey as well as part of their normal operations in Research for developing tools by involving users.

    Recommendation: The Commissioner of Internal Revenue should establish formal mechanisms for front-line users to interact directly with tool programmers and program analysts to ensure future network analysis tools, such as GraphQuery, are easy to use and help achieve goals.

    Agency Affected: Department of the Treasury: Internal Revenue Service


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