Abusive Tax Schemes: IRS Could Improve Its Reviews of Offshore Insurance Audits and Investigations
Fast Facts
Offshore insurance arrangements can be used to improperly claim tax benefits. One such arrangement that has been abused is micro-captive insurance—i.e., small insurance companies owned by the businesses they insure.
We found that IRS could improve how it reviews its audits and investigations of such arrangements. For example, IRS managers have little guidance for when an audit should have a managerial review. IRS also could improve how it records and analyzes its quality reviews of investigations.
We recommended that IRS clarify guidance on offshore micro-captive insurance audits and establish a formal review system for investigations.
Highlights
What GAO Found
To encourage voluntary compliance with tax laws concerning offshore insurance arrangements, the Internal Revenue Service (IRS) uses feedback from internal stakeholders and the public to review and modify applicable guidance. Offshore insurance has legitimate uses but also can be structured to hide U.S. taxpayers' assets or falsely claim tax benefits. Treasury and IRS have opportunities to better solicit public input on certain guidance, including for offshore insurance, as GAO recommended in its April 2021 report. Treasury neither agreed nor disagreed with the recommendation, but GAO maintains that the recommendation remains valid.
One offshore insurance issue that IRS has prioritized with enforcement is micro-captive insurance arrangements—that is, when small insurance companies insure related business entities. For example, micro-captive insurance has been included on IRS's “Dirty Dozen” tax schemes list. To ensure micro-captive insurance audits are conducted properly, IRS generally uses two approaches:
- Managerial reviews: These consist of various types of written reviews, including in-process case reviews and workload reviews, among others, performed by the managers overseeing the audit.
- Quality reviews: These are conducted by independent reviewers outside of the audit work-stream to ensure that all processes meet IRS's standards.
IRS officials said that current oversight practices were sufficient to ensure that micro-captive audits were conducted accurately. For example, IRS cited that from fiscal years 2016 through 2020, the Small Business and Self Employed Division's (SB/SE) managerial reviews found that performance on attributes of micro-captive insurance audits were conducted appropriately about 97 percent of the time, compared to about 92 percent for all audits in general.
However, IRS's application of its review approaches could be enhanced. For example, SB/SE's managers have little guidance in the Internal Revenue Manual for when an audit should be subjected to managerial review and Large Business and International Division (LB&I) managers lack systems through which to record and analyze certain managerial reviews. By clarifying guidance and establishing a formal review system, SB/SE and LB&I would have better assurance that they are effectively auditing micro-captive insurance.
IRS also investigates whether promoters of micro-captive insurance schemes violate tax law. IRS's oversight of promoter investigations has no systematic method that would enable IRS to evaluate the effectiveness of its micro-captive promoter investigation program. For example, SB/SE lacks a systematic method to identify micro-captive promoter investigations for quality review. From fiscal years 2016 through 2020, LB&I did not apply quality reviews to any micro-captive insurance promoter investigations. Conducting formal reviews more systematically would better assure the quality of IRS's promoter investigations on micro-captive arrangements.
Why GAO Did This Study
Tax evasion schemes involving offshore insurance are complex and resource-intensive for IRS to pursue, making it important for IRS to conduct compliance programs effectively.
GAO was asked to review how IRS conducts enforcement on offshore insurance compliance issues. This report evaluates to what extent IRS (1) reviews its guidance on offshore insurance to ensure that the guidance has its intended effect; (2) aligns oversight of its audit activities on taxpayers who may be abusing micro-captive insurance tax shelters with IRS audit policies and guidance; and (3) reviews its investigation activities on promoters who market abuses of offshore insurance tax shelters.
GAO reviewed IRS procedures on issuing guidance and on reviews of audits and promoter investigations, reviewed files on audits related to micro-captive insurance tax schemes, interviewed IRS officials, and compared IRS procedures with IRS policies and selected federal standards for internal control.
Recommendations
GAO is making seven recommendations to improve how IRS oversees, through managerial reviews and independent quality reviews, its taxpayer audits and promoter investigations involving micro-captive insurance arrangements. IRS disagreed with the recommendations, stating that its current procedures are sufficient and citing resource constraints. However, GAO maintains that IRS's procedures should be refined and can be done so with minimal use of resources.
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| Internal Revenue Service | The Commissioner of Internal Revenue should have SB/SE provide more specific guidance on when SB/SE should use various managerial review tools and the frequency with which such reviews should be conducted on high-priority matters such as those surrounding micro-captive insurance arrangements. (Recommendation 1) |
In a letter from October 2022, IRS disagreed with this recommendation, stating that SB/SE area directors annually issue guidance on requirements for minimum review and documentation to their managers, and provided examples of such guidance. However, none of the information IRS provided fully addresses the specifics of GAO's recommendation. First, the annual guidance examples do not consistently provide managers with expectations for reviews of priority work and types of cases to be reviewed. Second, while SB/SE states that the annual guidance documents are consistent with the IRM, the IRM does not provide direction or guidance as to how or when high-priority cases should be subject to managerial review. Finally, the IRM does not clearly state that all types of managerial review will be conducted according to the SB/SE area director's annual guidance. In September 2024, IRS said it had not changed its position. GAO will continue to monitor IRS for additional action. By implementing this recommendation, IRS will have greater assurance that it is achieving its audit goals for micro-captive insurance.
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| Internal Revenue Service | The Commissioner of Internal Revenue should have LB&I adopt formal managerial reviews of its audits and establish methods and procedures for recording and analyzing managerial review data that allow it to isolate high-priority cases, including micro-captive insurance audits, and use the data to assess the quality of its audits. (Recommendation 2) |
In a letter from October 2022, IRS disagreed with this recommendation, stating that its current processes are sufficient. GAO maintains that IRS's procedures should be refined. In September 2024, IRS said it had not changed its position. GAO will continue to monitor IRS for additional action. By implementing this recommendation, IRS will have greater assurance that its audits meet its quality standards.
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| Internal Revenue Service | The Commissioner of Internal Revenue should have SB/SE and LB&I subject a sample of their micro-captive insurance audits to a formal quality review process. Based on the findings of this review, SB/SE and LB&I should take corrective action to remedy any deficiencies. (Recommendation 3) |
In a letter from October 2022, IRS disagreed with this recommendation, stating that its current processes are sufficient. However, GAO's recommendation addresses quality assurance at a higher level than the conduct of the audit itself and would provide greater assurance of audit quality on micro-captive audits moving forward. Furthermore, as indicated in GAO's report, only a small portion of micro-captive audits have been subjected to formal quality review. GAO maintains that IRS's procedures should be refined. In September 2024, IRS said it had not changed its position. GAO will continue to monitor IRS for additional action. By implementing this recommendation, IRS will be better able to detect potential problems with its micro-captive audits and take corrective actions.
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| Internal Revenue Service | The Commissioner of Internal Revenue should have SB/SE design and implement an identification and tracking method in EQRS to allow agency officials to readily identify and compare managerial reviews of microcaptive promoter investigations, both to other micro-captive promoter investigations, and promoter investigations generally, and use the data to assess the quality of its promoter investigations. (Recommendation 4) |
In a letter from October 2022, IRS disagreed with this recommendation, stating that IRS can use project codes in EQRS to identify, track, and compare managerial reviews of micro-captive promoter investigations. However, as noted in GAO's report, officials relied on a manual process to distinguish micro-captive investigations from micro-captive audits. In September 2024, IRS said it had not changed its position. GAO will continue to monitor IRS for additional action. By implementing this recommendation, IRS will be better able to assess the quality of its micro-captive audits and make any necessary changes to enhance quality.
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| Internal Revenue Service | The Commissioner of Internal Revenue should have LB&I adopt formal managerial reviews of micro-captive insurance promoter investigations, establish a reliable way to store and track managerial review data of promoter investigations that allows it to isolate high priority cases, issue guidance on how often and by what method such investigations should be subjected to managerial review, and use the data to assess the quality of its promoter investigations. (Recommendation 5) |
In a letter from October 2022, IRS disagreed with this recommendation, stating that LB&I promoter investigations already are subject to 100 percent managerial review. However, as mentioned in GAO's report, these reviews are not all documented in a way that LB&I could compile and analyze. The IRM requires that managers evaluate and recommend changes to their penalty program, which includes micro-captive promoter investigations. However, LB&I lacks an electronic method to identify, document, and analyze managerial reviews of such investigations for trends, anomalies, or potential deficiencies. In September 2024, IRS said it had not changed its position. GAO will continue to monitor IRS for additional action. By implementing this recommendation, IRS will gain a more thorough understanding of promoter case quality and better detect potential emerging quality issues.
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| Internal Revenue Service | The Commissioner of Internal Revenue should have SB/SE develop a method to assess the quality of promoter investigations and apply this method to micro-captive promoter investigations. Based on these reviews, SB/SE should take corrective action to remedy any deficiencies uncovered in its analysis. (Recommendation 6) |
In a letter from October 2022, IRS disagreed with this recommendation, stating that SB/SE already has a method to assure investigation quality and that the success of these investigations shows that the quality assurance methods in place are sufficient. However, as described in GAO's report, SB/SE managerial reviews are only made during the investigation process. IRS would be better assured of the overall quality of its micro-captive investigations more broadly with higher-level, independent reviews. In September 2024, IRS said it had not changed its position. GAO will continue to monitor IRS for additional action. By implementing this recommendation, IRS will better assure audit quality of micro-captive insurance promoter cases.
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| Internal Revenue Service | The Commissioner of Internal Revenue should have LB&I establish and implement metrics on promoter investigation quality and subject a set of micro-captive promoter penalty investigations to formal quality review procedures to establish a baseline measure of micro-captive promoter investigation quality. Based on these reviews, LB&I should take corrective action to remedy any deficiencies uncovered in its analysis. (Recommendation 7) |
In a letter from October 2022, IRS disagreed with this recommendation, stating that LB&I promoter investigations are subject to managerial review and that developing metrics would not provide meaningful insight because each case is "so unique that setting metrics applicable to the entire population would not provide meaningful insight." GAO believes that if IRS can create quality standards for LB&I audits, it can do so for LB&I investigations and perhaps can look to its LQMS quality review procedures as a model for possible metrics in fulfilling this recommendation. In September 2024, IRS said it had not changed its position. GAO will continue to monitor IRS for additional action. By implementing this recommendation, IRS will better assure proper application of promoter penalties in micro-captive cases.
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