Abusive Tax Avoidance Transactions: IRS Needs Better Data to Inform Decisions about Transactions
Published: 2011-05-12T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Abusive tax avoidance transactions (ATAT) range from frivolous tax schemes to highly technical and abusive tax shelters marketed to taxpayers by promoters selling tax advice. ATATs threaten the U.S. tax system's integrity if honest taxpayers believe that others do not pay their fair share of taxes. GAO was asked to (1) describe what is known about trends in ATAT usage; (2) describe results of IRS's ATAT enforcement efforts; and (3) evaluate IRS's implementation of the ATAT provisions in the American Jobs Creation Act of 2004. Using criteria from the act, GAO analyzed statistics and other documents on trends and results and interviewed IRS and other tax experts.
section_title: What GAO Found
paragraphs: While trend data on taxpayers' use of ATATs are limited, IRS and other experts GAO contacted agreed that a problem exists and is continually changing. One theme that emerged from 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. IRS has many ATAT-related enforcement efforts--investigations, examinations, and settlement initiatives--across different divisions but has incomplete data on the results on those efforts. For example, IRS's small business division's promoter investigations help stop promotions, but IRS had incomplete information on why investigations often closed without penalties or injunctions, information that could be used to help decide the types of investigations to start. In addition, IRS recommended billions of dollars in additional taxes from examining tax returns with suspected ATATs, but 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 IRS divisions. Without comprehensive or consistent information, 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 the 2004 act increased the requirements for taxpayers and promoters to disclose their use of transactions and enhanced the penalties for improper disclosure, problems existed. 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, 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 IRS from having information needed to identify the transactions that merit an examination of their appropriateness and to assess related penalties as needed. Finally, certain promoters who are required by law under threat of penalty to give their list of investors within 20 business days after IRS requested it did so. However, 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. IRS did not comprehensively track how quickly the lists were received. Not receiving lists on a timely basis prevents IRS from quickly working to stop promoter activity. GAO suggests that Congress consider instituting a penalty aimed at certain promoters not giving investor lists to IRS within a specified time. GAO also recommends IRS act or establish processes to (1) improve data on the results of ATAT-related investigations and examinations, (2) ensure that required disclosures are filed by taxpayers, (3) review disclosures for completeness; (4) track the time for IRS to receive investor lists; and (5) induce more promoters to provide investor lists by a specified time. In commenting on a draft of this report, IRS agreed with most recommendations but cited resource and capability constraints in tracking ATAT data and investor lists, which GAO believes can be addressed.

section_title: Letter
paragraphs: Abusive tax avoidance transactions (ATAT) range from tax schemes based  on clearly frivolous arguments to highly technical and abusive tax shelters  engineered and marketed by firms. As characterized by the Internal  Revenue Service (IRS), ATATs take a tax position that is not supported by  tax law or manipulate the law in a way that is not consistent with the law’s  intent. Promoters (including material advisors) may encourage the use of  these abusive transactions by their customers. In 2003, we reported that  IRS officials estimated that several hundred thousand participants were  likely engaged in abusive tax avoidance schemes. In addition, we reported  that IRS data sources, all with limitations, suggested that abusive tax  shelters totaled tens of billions of dollars of potential tax losses over about  a decade. ATATs threaten our tax system’s integrity and fairness if honest  taxpayers believe that significant numbers of individuals and businesses  are not paying their fair share of taxes.
Since our 2003 work, the American Jobs Creation Act of 2004 (AJCA)  addressed ATATs through disclosure and penalty provisions. Interested in  the act’s effectiveness, you asked us to report on IRS’s efforts to address  it. The objectives of this report are to:    describe what IRS and other experts know about trends in the use of    describe the results that IRS’s promoter investigations, investor  examinations, and settlement initiatives have achieved; and  evaluate the results of IRS’s implementation of the ATAT disclosure  and sanction provisions enacted in the AJCA.
To address these objectives, we did the following (see app. I for details  about our scope and methodology):  reviewed IRS’s documentation on ATAT trends, including its most  recent report on the size of the ATAT problem, and interviewed IRS  officials and outside tax experts—former high-level IRS officials and  their suggested contacts—about these ATAT trends and whether the  nature of ATAT problems changed in sophistication or scope in recent  years;  analyzed IRS investigation, examination, and settlement initiative  statistics, focusing on two IRS divisions that pursue abusive promoters  and that our 2003 work highlighted—the Large Business and  International (LB&I) division and the Small Business/Self-Employed  (SB/SE) division, and interviewed IRS officials about why IRS did  certain investigations and examinations and not others; and    using criteria inherent in the AJCA, evaluated (1) ATAT disclosures to  IRS and their level of completeness, (2) IRS’s requests for the lists of  investors in ATATs from tax advisors, and (3) ATAT penalties and  other sanctions used since 2004, and interviewed IRS officials on why  some disclosures were required to be sent to two places in IRS and  how well that requirement worked.
We conducted this performance audit from July 2009 through May 2011 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
subsections: section_title: Background
paragraphs: If ATATs are highly technical and organized or marketed, they are often  referred to as abusive tax shelters. According to IRS, abusive tax shelters  result in unlawful tax evasion. Our report on business network-based tax  evasion illustrates how one type of evasive transaction—the installment  sale bogus optional basis—operated. ATATs also include abusive  transactions that are considered scams or schemes based on the  erroneous application of tax law or clearly frivolous arguments.
Tax shelters can be legitimate to the extent that they take advantage of  various provisions in the tax code to lawfully avoid tax. For instance,  retirement plans (e.g., 401(k)) shelter income by not subjecting certain  wages to federal income taxes until the wages are distributed from the  plan. Tax shelters can feature such techniques as taxpayers trying to avoid  gains altogether or to convert ordinary income into capital gains to take  advantage of lower tax rates on capital gains.
A difficulty arises when tax shelters are designed to confer a tax benefit  that the Congress did not intend. An example of this type of shelter is the  lease-in, lease-out (LILO) shelter that involved complex purported leasing  arrangements in which corporations supposedly leased large assets, such  as sewer systems, from owners without a tax liability and immediately  leased them back to their original owners in an attempt to delay income  recognition for tax purposes for many years.
ATATs have been a long-standing problem that the Congress, Treasury,  and IRS have used different methods to address. For example, the Tax  Reform Act of 1986 addressed tax shelters from the 1970s and 1980s by  preventing individual taxpayers from using “passive activity” losses from  tax shelter investments to reduce taxes by offsetting taxable income.
Interest in abusive tax shelters picked up again in the 1990s. In 1999, a  Department of the Treasury report described a large and growing problem  with abusive corporate tax shelters. In 2002, citing many ongoing efforts,  Treasury published a plan to further combat ATATs, featuring both  legislative proposals and administrative actions. In 2004, the AJCA  provided updated disclosure and list-maintenance rules and updated  penalty provisions. The list-maintenance rules require that material  advisors keep lists of their investors and make the lists available to the  Secretary of the Treasury within 20 business days of a request. For a  summary of selected provisions of the AJCA related to ATATs, see  appendix II.
Over time, Treasury’s strategy for addressing tax shelters centered on  rules that were intended to reinforce each other. The rules attempted to do  this by requiring taxpayers entering into certain transactions and tax  advisors recommending the transactions to disclose to IRS information  about the same transactions. The idea was that using these rules, IRS  could follow a transaction from a taxpayer to the taxpayer’s advisor and  from the advisor to any of the advisor’s clients.
The rules require specified taxpayers to disclose “reportable  transactions.” These transactions include “listed transactions” that are  the same or substantially similar to one of the types of transactions that  IRS has determined to be a tax avoidance transaction and identified by  notice, regulation or other published guidance. Reportable transactions  also include “non-listed” transactions, which are not designated as tax  avoidance transactions but prompt tax avoidance or evasion concerns  nonetheless. Non-listed reportable transactions include certain  transactions (1) offered to a taxpayer under conditions of confidentiality  and for which the taxpayer paid an advisor a minimum fee and (2) certain  loss transactions. Non-reportable abusive transactions are abusive  transactions not described in one of the reportable categories. For a  comparison of requirements for reportable and non-reportable  transactions and a description of how taxpayers, material advisors and  other promoters, and IRS interact with each other, see figure 1.
IRS has had various forms for filers reporting ATAT information. For  example, taxpayers are to file Form 8886, Reportable Transaction  Disclosure Statement, to disclose their reportable transactions. Form 8918,  Material Advisor Disclosure Statement, is to be filed by material advisors.  This form was created in 2007 to replace Form 8264, Application for  Registration of a Tax Shelter, which was to be filed by tax shelter  organizers in order to describe a transaction and its tax benefits when the  transaction had certain potentially abusive characteristics.
To enforce compliance, IRS has three interlocking efforts: promoter  investigations, investor examinations, and settlements. Figure 2 focuses on  two IRS operating divisions—LB&I and SB/SE—that develop and evaluate  promoter leads for investigation and shows how each division coordinates  with others, including the Servicewide Abusive Transaction Executive  Steering Committee.
To make a case against abusive promoters, LB&I or SB/SE may examine  the tax returns of taxpayers investing in the promotions. If they make such  a case, the promoters will be unable to sell their ATATs to taxpayers, and  IRS will thus have fewer taxpayers to examine to see if their investments  in those promotions cause tax concerns. IRS may also settle with groups  of taxpayers without necessarily having to first locate and examine each  taxpayer who used a promotion. IRS induces these taxpayers to come  forward in disputed matters by, in some cases, reducing their penalties in  exchange for conceding tax benefits that they claimed.
section_title: IRS Has Limited Trend Data on the Extent of Abusive Transactions, but Many Tax Experts Said That the Ever- Changing Nature of ATATs Requires Constant Vigilance
paragraphs: IRS has limited trend data on the size of the ATAT problem in terms of the  number of abusive promoters and taxpayers investing in the promotions.  Estimating the extent of ATATs is at best an inexact process because  ATATs are often hidden. Data do not exist to measure any ATATs  unknown to IRS with much precision. Given these difficulties, IRS used  various qualitative and quantitative methods in an attempt to develop  some estimates in a 2006 study. IRS estimated that about 1 million tax  returns and between about 11,000 and 15,000 promoters were involved in  ATATs in 2004. Of the 1 million returns, IRS estimated that more than half  related to “business and deduction” schemes and almost a third involved  “frivolous filer/anti-tax” schemes. IRS put the rest of the returns into six  other categories, such as corporate tax shelters. IRS had no plans to  update these estimates.
In the absence of data on trends in the use of ATATs, we interviewed a  number of tax experts in IRS or who were former top officials of IRS or  others well-known in the tax community. The experts we interviewed told  us that abusive tax avoidance is still a major issue but the nature of ATATs  has changed. A theme we heard from the experts is that the mass  marketing of ATATs has declined in recent years, although the experts had  different views on the extent of the decline. Mass marketing refers to the  sale of advice by promoters such as larger accounting and tax law firms  about how to structure ATATs. This advice was sold to clients such as  wealthy individuals and corporations. One expert said that mass  marketing of ATATs has significantly declined in recent years. Others  made statements like the battle has been “more won than not.”
Although mass marketing of ATATs has declined, these experts said that  ATATs have become more sophisticated and international in scope. In  addition to international transactions, ATATs are changing as false credits  and deductions, customized shelters, and return preparer fraud entities  have come more to the fore. IRS’s “dirty dozen” list, its annual listing of  “notorious tax scams,” ranks certain abuses that are relevant to ATATs—  such as return preparer fraud and trying to hide income offshore—at the  top.
The experts we interviewed gave us details about how ATATs involving  international features or tax return preparers changed. For instance, one  expert believed abuse took the form of improperly keeping income  offshore and not reporting it on a tax return. IRS officials said that abusive  transactions moved from being domestic transactions mass marketed by  large accounting and law firms to offshore transactions promoted by  smaller entities and more customized to the buyers. IRS officials also said  that ATATs seemed more international than before, with promoters  changing the countries and mechanics of their promotions. In terms of tax  return preparers, IRS officials told us of promotions systematically using  false or inflated deductions or credits in tax returns. These schemes  achieved broad coverage by taking small scale abusive positions with  individual clients. For instance, preparers solicited clients in an attempt to  improperly claim the First-Time Homebuyer Credit, which first came into  existence in 2008.
Experts also told us that the nature of the ATAT problem is cyclical and  ever-changing and warrants continuous IRS vigilance. According to IRS  officials, IRS tries to proactively identify and thwart emerging ATATs,  especially early in their life cycles, pointing to early IRS identification of  taxpayers’ attempts to improperly claim the First-Time Homebuyer Credit.
Three data sources other than the above IRS estimates also give some  indication of changes in ATAT activity. First, taxpayers are disclosing  fewer listed reportable transactions (which are designated as tax  avoidance transactions) to IRS on Forms 8886. Taxpayers disclosed about  6,100 of these transactions in 2007 and about 1,300 each in 2008 and 2009.  However, IRS cannot know how many listed transactions should have  been disclosed but were not.
Second, the cumulative number of transaction types that IRS has “listed”  since 2000 has leveled off at 36. As figure 3 shows, IRS did not designate  any new listed transactions in years 2008 through 2010. IRS officials said  they detected fewer widely promoted avoidance transactions suitable for  listing in recent years. However, the number of transaction types that are  listed is not an indication of how many promoters or taxpayers are using  them.
Third, IRS identified two transactions of interest (TOI) in both 2007 and  2008 but none in 2009 or 2010. IRS designates a new promotion that has  the potential for tax avoidance or evasion as a TOI when IRS lacks  information to decide whether to list it as a tax avoidance transaction.  Doing so triggers a requirement for the taxpayers involved to disclose  information about the transaction to IRS on Form 8886.
section_title: IRS Shows Vigilance over ATATs in Its Enforcement Efforts, but Quantifying the Impact of the Efforts Is Difficult
paragraphs: IRS has investigated promoters in an effort to stop ATATs, examined the  tax returns of taxpayers participating in ATATs, and initiated settlements  with groups of taxpayers without necessarily having to first locate and  examine each taxpayer using the ATAT. IRS efforts in these three areas  are consistent with what we heard about how the ever-changing problems  with ATATs merit continued vigilance.
However, IRS has difficulty quantifying the IRS-wide impact of these  efforts on the ATAT problem. As context for discussing such IRS-wide  impacts, several examination and settlement initiative projects considered  by the Servicewide Abusive Transaction Executive Steering Committee  showed the challenges of working across IRS units. An internal IRS report  noted that decisions by different divisions on how and when to report  results on their work for one IRS-wide settlement initiative initially  resulted in inconsistent briefings to the Enforcement Committee, to which  the Steering Committee reports. Another IRS team working on an ATAT  issue informed the Steering Committee about obstacles to coordinating  among IRS units and about needed mitigations. As our business networks  report indicated, competing examination efforts or plans across divisions  made prioritization difficult.
subsections: section_title: Investigations of Promoters Stopped Some Abuse, but IRS Has Incomplete Information on Why Many Investigations Were Closed without Penalties or Injunctions
paragraphs: For fiscal years 2006 through 2010, about 100 SB/SE promoter  investigations annually resulted in injunctions for promoters to stop what  they were doing and/or penalties for what they did, as table 1 shows. The  561 investigations over the 5 years resulting in injunctions or penalties  were 38 percent of all investigations closed. For the same years, SB/SE  closed (e.g., discontinued for various reasons) 905 investigations (62  percent) without penalties or injunctions.
This annual level of SB/SE investigations shows IRS’s vigilance in  attempting to identify and pursue leads to address ATATs. According to  Lead Development Center (LDC) officials and documents, LDC develops  leads received from such sources as IRS revenue agents and officers and  practicing accountants who suggest an individual may be involved in an  abusive promotion. IRS field offices decide whether to pursue an  investigation. If an investigation cannot sustain a penalty or injunction, it  can be surveyed (closed without promoter contact) or discontinued  (closed after promoter contact). LDC officials said that the reasons for  surveyed or discontinued investigations include the difficulty in proving  abuse, the need to balance limited resources and many priorities in  addressing the most egregious promoters, and the lack of harm to the  government.
IRS had incomplete data on why investigations were discontinued or  surveyed. In fiscal year 2009, SB/SE discontinued 84 investigations,  surveyed 46, and closed 1 because the promoter died. Of the 130 cases  surveyed or discontinued, we could not analyze 30 because LDC officials  said they did not receive the documentation and 3 because the  documentation was incomplete. In over 65 percent of the other 97 cases  we could analyze, the investigations closed because the parties were not  actively promoting abusive transactions or because IRS could not obtain  enough evidence to support a penalty or injunction.
In February 2011, LDC started using codes to capture the reasons for  surveying or discontinuing promoter investigations to have more complete  data on these reasons. SB/SE officials told us they plan to promote  consistency in the use of the reason codes by asking field offices to  describe why they selected the codes for each case and by continually  analyzing the different codes used. Because this process had just started,  we had no assurance how these plans would work or how the reason-code  data would be used to make decisions on the types of investigations to  start.
IRS had no criteria to indicate whether the SB/SE investigation results in  table 1 were at desired levels. While the effectiveness of injunctions is  apparent when they stop promotions, tax experts questioned the  effectiveness of penalties if they do not deter those who will risk a penalty  to engage in an abusive promotion. Without criteria, IRS could not say  whether having 62 percent of investigations closed without penalties or  injunctions was too many, too few, or about right, which would be  important information in deciding which types of cases to select for  investigation.
Regardless, IRS officials said that closing 62 percent of investigations  without penalty or injunction did not indicate any flaws. They said that  decisions about doing an investigation usually cannot be made without  some field work; decisions about continuing an investigation with  additional field work must be balanced with the available field resources.  These officials said they continually look for ways to develop and refine  leads before turning them over to investigators because successful  investigations of promoters drive unscrupulous individuals out of  business.
section_title: IRS Examined Thousands of Tax Returns Involving Suspected ATATs and Recommended Billions of Dollars in Additional Taxes, but the Impact Is Unclear
paragraphs: The impact of examinations on the ATAT problem is uncertain.  Examinations of the returns from taxpayers involved in suspected ATATs  recommended billions of dollars in additional tax assessments from fiscal  years 2006 through 2010. IRS did not track how much of these  recommended amounts came from the ATATs versus other tax issues.  Further, the recommended amounts may not produce actual tax  assessments or collections when taxpayers dispute the recommended  amounts in the appellate or litigation processes. For examinations closed  in fiscal years 2006 through 2010:    LB&I examinations of 9,400 tax returns with suspected ATATs  recommended additional assessments for all tax issues of $42.4 billion,  of which taxpayers disagreed with about 84 percent.
SB/SE examinations of 125,700 returns with suspected ATATs  recommended additional assessments for all issues of $6 billion, of  which taxpayers contested at least 54 percent in IRS’s Appeals office.
Neither LB&I nor SB/SE readily tracked how much of the additional taxes  were ultimately assessed and collected after examinations for either ATAT  or all tax issues. IRS officials told us that they started tracking amounts  collected from examinations that included ATAT issues on a monthly basis  during fiscal year 2011, but the tracking does not isolate the amounts  coming from the ATAT (as opposed to other) issues.
For examinations that included taxpayer disclosures of reportable  transactions filed with OTSA, OTSA did not have a comprehensive view of  the results of examinations done by LB&I and SB/SE. After OTSA sends  the disclosures to LB&I and SB/SE for possible examination, OTSA relies  on the two IRS divisions to report back on the results. However, each  division reported results differently.
For LB&I examinations, the examiners were the source on the  examination results. OTSA officials said the examiners did not report back  on all results in a consistent manner because they were not required to do  so. For SB/SE examinations of the disclosures, SB/SE officials said they  collected the results for OTSA from data systems and not from examiners.  In general, SB/SE and LB&I officials said that divisions track information  differently because of different needs. For example, SB/SE relies more on  electronically capturing examination results because it does more  examinations of shorter duration compared to LB&I.
According to SB/SE officials, SB/SE was unable to provide OTSA with data  in time for the May 2010 annual report to the Joint Committee on Taxation  due to its larger number of examinations. These SB/SE officials also said  that they did not review the accuracy of the SB/SE data used in the annual  reports. Without comprehensive or consistent results on examinations of  ATAT disclosures for the report to the Joint Committee, IRS cannot be  certain it is providing reliable information to the Congress. Nor will IRS  executives have the best information available for making decisions about  the number of examinations to do and for evaluating their impacts.
section_title: IRS’s Settlement Initiatives Involved Billions of Dollars, but Amounts Collected and the Effect on ATATs Cannot Always Be Isolated
paragraphs: In various ATAT settlement initiatives, IRS provided inducements for  taxpayers to come forward to IRS to resolve disputed matters. The  inducements sometimes took the form of reducing taxpayers’ penalties in  exchange for taxpayers conceding tax benefits that they claimed. IRS  reported to the Joint Committee on Taxation that it had collected billions  of dollars from taxes, penalties, and interest from the beginning of its 17  ATAT settlement initiatives through early 2010.
These dollar figures should not be considered the final word in describing  the 17 initiatives’ results through early 2010. On one hand, they did not  include the results of field work and litigation still occurring at the time of  that report. On the other hand, initiative results included some collections  from taxpayers who did not participate in the settlement but whose tax  returns had been examined because they were related to the relevant  transaction. Also, according to IRS officials, initiative results sometimes  included issues not targeted by the initiative. As noted earlier, IRS’s  enforcement tracking systems only track ATAT results by case and not by  separate tax issues within a case.
Furthermore, the dollar amounts collected for the 17 ATAT initiatives  were not reported consistently to the Joint Committee on Taxation. For  instance, the dollar amount for the Global Settlement Initiative, which  aimed to resolve 21 unrelated abusive transaction issues under one  framework, was the amount of additional tax recommended, not the  amount collected. Also, the total for all of the ATAT initiatives as reported  to the Joint Committee did not include any dollars collected from the very  large-dollar LILO and similar Sale-In/Lease-Out (SILO) ATAT initiatives.  The responsible IRS group did not provide data on the LILO initiative and  provided data on adjustments to taxable income, rather than the amount  collected, on the SILO initiative. Lacking data on how much additional tax  ultimately was collected limits information on the impact of the settlement  initiative.
Better tracking of dollar collections could be considered for future  initiatives. However, IRS has not seen the need to start new ATAT  initiatives, which could be consistent with experts’ view that the extent of  the ATAT problem has eased. Further, isolating the impact on ATATs of  settlement initiatives from the impacts of examinations and promoter  investigations is difficult to do, especially when IRS does not have an IRS- wide system for tracking and comparing the results from its enforcement  efforts.
section_title: The AJCA Increased Abusive Transaction Disclosure Requirements and Penalties, but Problems Remained
paragraphs: The AJCA provided new tools to address ATATs. For material advisors, it  revised the requirements to disclose reportable transactions and provide  lists of their investors to IRS upon request or face penalties. For taxpayers,  the AJCA established requirements to disclose reportable transactions or  be subject to enhanced penalties.
OTSA received thousands of Forms 8886 from taxpayers to disclose  reportable transactions for 2007 through 2009, as table 2 shows. Almost all  of these disclosures were associated with loss transactions—most of the  losses had not been deemed by IRS to be tax avoidance. OTSA officials  said that the number of disclosures dropped in 2008 because IRS  combined multiple disclosures from one taxpayer into one disclosure, and  increased in 2009 because economic conditions generated more losses  that were disclosed as reportable transactions.
If taxpayers do not file all required Forms 8886 or file incomplete or  inaccurate forms, IRS would lack the information that it needs to make  decisions on whether to examine the appropriateness of the transactions  being disclosed by taxpayers. Without this transparency, abusive  transactions are more likely to stay hidden from IRS.
subsections: section_title: OTSA Did Not Verify That It Received All Required Disclosures or That They Were Complete
subsections: section_title: OTSA Did Not Verify That It Received All Disclosures from Taxpayers
paragraphs: According to OTSA officials, OTSA did not confirm that it always received  its copy of the required Form 8886 from taxpayers disclosing a reportable  transaction. Taxpayers must file one copy of the form with their tax return  and send a second copy directly to OTSA for their initial year of  participation. Absent a system to confirm that OTSA always received its  copy, IRS cannot know how prevalent this problem might be. However,  IRS knows that a problem exists because, according to IRS officials, IRS  examiners of tax returns have identified some taxpayers who filed their  Form 8886 with their tax return but failed to send it to OTSA. If OTSA does  not receive disclosures, it cannot identify transactions that merit  examination for appropriateness as well as possible penalties.
For individual tax returns filed on paper, IRS had no return processing  indicator that would specify when a Form 8886 was received with all types  of returns. IRS had an indicator for corporate, partnership, estate and  trust, and tax-exempt returns but did not update that indicator to cover all  types of returns when it created the Form 8886; extensive computer  programming would have been required. For electronically-filed tax  returns with Form 8886 disclosures, OTSA officials said that they did not  use existing IRS data to verify if they received copies of the forms. In 2008,  OTSA investigated the viability of doing a match to verify if it received its  copies. OTSA had data problems and had not made the match a high  priority. OTSA officials said it will not do any match until it also covers  paper-filed returns to adhere to IRS’s policy on treating paper- and  electronically-filed returns equally for purposes of verification.
Recognizing this policy, OTSA officials said that IRS was establishing a  new indicator for paper and electronic tax returns to identify each Form  8886 filed. OTSA officials said that the new indicator, if it works as  intended, would allow them to identify paper and electronic Form 8886  disclosures that OTSA has not received. OTSA officials said that the new  indicator would not be operational until September 2012 for use with 2011  tax returns filed in 2012.
Given that checking compliance in filing required Forms 8886 would be  facilitated by electronically-filed tax returns, OTSA does annual studies on  whether it should pursue authority from the Congress for mandatory  electronic filing for all taxpayers who file Form 8886. Studies done in  2008, 2009, and 2010 indicated that mandatory electronic filing would  make processing the Form 8886 less time- and labor-intensive and more  accurate. However, all three studies concluded that mandating electronic  filing was not currently viable or realistic, mainly because, according to  the study reports, the great majority of taxpayers filing the Form 8886 did  not already file their tax returns electronically and would have to change  their filing format. For example, for all Form 8886 filers in processing year  2009, 14 percent filed their tax return electronically, including 43 percent  of corporate filers, 32 percent of partnership filers, 11 percent of individual  filers, and 3 percent of estate and trust filers.
However, these OTSA studies did not examine whether the returns were  already being prepared on computers. If they were, taxpayers could more  readily comply with an electronic filing mandate. IRS data compiled from  codes collected on tax returns show that about two thirds of all paper  returns in 2008 (and about 92 percent when a paid preparer was used)  were prepared on a computer, printed, and mailed to IRS. As another  indication of the feasibility of requiring electronic filing, the median  adjusted gross income for individual Form 8886 filers in 2006 was about  $1.4 million—an income level that would likely be able to afford a  computer or a paid preparer in filing tax returns.
Instead of pursuing mandatory electronic filing, IRS planned to begin using  barcode technology in early 2011. IRS’s plan assumes that taxpayers can  use computers to download and complete the Form 8886 from the irs.gov  Web site. A barcode on the Form 8886 will be updated automatically from  specific fields on the form and then printed on the paper return. IRS can  then scan the barcode without verifying the information. Even in this case,  taxpayers would still need to send a paper copy of their Form 8886 directly  to OTSA.
section_title: OTSA May Not Have Received All Forms from Material Advisors
paragraphs: Material advisors may not have filed all of their Forms 8918 or 8264 with  OTSA, as required. By analyzing IRS Statistics of Income (SOI) samples  of 2007 partnership and S corporation tax returns, we found 668 entities  that reported that they filed or were required to file a material advisor  form on a reportable transaction. When we matched the Employer  Identification Numbers of these entities against the identifying numbers  that appeared on the Forms 8918 and 8264 in OTSA’s material advisor  database, only about 5 percent of the 668 entities appeared in the  database.
For 2007, OTSA believed many partnership and S corporation filers likely  confused the citation specified for material advisors (Internal Revenue  Code (IRC) section 6111) with section 6011, which deals with the investor  disclosure on Form 8886. As the section numbers are similar and the  partnership and S corporation forms did not specifically ask if the  taxpayer filed a Form 8918 or was a material advisor, OTSA believed that  the filers would incorrectly answer the section 6111 question on the  return, thinking that they were affirming they had a section 6011  obligation. In 2008 and 2010, IRS revised the relevant question on the  partnership and S corporation forms, respectively, specifically mentioning  the Form 8918 and material advisor disclosure. OTSA believes this change  will correct the mismatches we found. It intends to match the material  advisor database against SOI data for 2008 partnership forms to determine  if the disparity persists in a year after the question revision. However,  matching S corporation data would have to await the availability of SOI  information for 2010.
section_title: IRS Did Not Verify That All Disclosures Were Complete
paragraphs: IRS received more than 325,000 Forms 8886 for 2006 through 2009. IRS  reviewed about 10 percent for completeness, which meant that IRS could  understand the transaction and its tax benefits and identify the parties  involved. After the review, IRS sent 177 letters to taxpayers on apparently  incomplete disclosures, asking for the missing information to be  submitted. IRS later determined that 111 (63 percent) of the taxpayers  responding did not have either a disclosure requirement or a completeness  issue. For various reasons, IRS did not resolve whether all of the other 66  taxpayers had disclosure requirements or complete disclosures.
In January 2011, OTSA officials said they were contemplating a new  process for reviewing all disclosures for completeness based on a 10- question checklist. The completed checklist is to be used to determine  whether the disclosure is incomplete and what action to take. OTSA  officials said that final decisions on the details of the process have not  been made and that the process would not be established until the 2012  filing season at the earliest. Afterward, its success would not be analyzed  until after two years of reviews had occurred according to these officials.
As a result, IRS will not know for at least two years whether the new  process will overcome the previous problems in deciding if disclosures  were really incomplete and in following up with the taxpayers. Without an  adequate review process in place, IRS risks accepting filed disclosure  forms from taxpayers that do not completely describe the potentially  abusive transaction.
section_title: Non-Material Advisors Did Not Provide Investor Lists to IRS in a Timely Manner and Do Not Face Timeliness Penalties, unlike Material Advisors
paragraphs: Even if the promoter is not a material advisor, IRS still can request lists of  investors. Promoters of abusive schemes who do not provide lists to IRS  when requested could continue their schemes. Receiving investor lists  from these promoters sooner enables IRS to more quickly determine any  harm to the government and obtain injunctions working with the  Department of Justice to stop abusive promoter activity.
OTSA officials said they were unaware of IRS comprehensively tracking  how often lists requested from material advisors were not received on  time. IRS had data on how often material advisors were penalized for not  keeping the lists or providing them on time. For 2008 and 2009, OTSA  received 11 investor lists within the required 20 business days after the  request under section 6112 and did not need to assess timeliness-related  penalties under IRC section 6708. Outside of OTSA, IRS assessed five  penalties against material advisors for requested investor lists during 2008  and 2009.
Unlike for material advisors, non-material advisors are not subject to the  20-business-day standard for timeliness under section 6112, or to the  section 6708 penalty for not meeting that timeliness standard. Based on  our interviews with 27 SB/SE revenue agents who do promoter  investigations, they generally agreed that many of the non-material  advisors do not quickly provide the lists. We sought such information from  SB/SE revenue agents who investigated promoters because most of their  investigations involve non-material advisors and because SB/SE did not  track how often and how quickly the requested investor lists are received.  Fourteen agents provided data on how quickly they received the lists for  54 ongoing investigations of non-material advisors. These non- generalizable data show that IRS received 13 of the 54 requested lists (24  percent) within 20 business days of the request date. IRS received another  22 lists (41 percent) after the 20 days (7 months to receive on average).  IRS had not received 19 lists, (35 percent) of which 18 had exceeded 20  business days.
To induce non-material advisors to provide investor lists, the agents  provided options and differing opinions on their possible impacts.
Many agents said that they issued summonses for investor lists. Some  said that bringing a summons to their first meeting with a promoter  expedited receiving the lists while one agent said that some local IRS  offices do not encourage bringing a summons to the first meeting.
Agents said that extending the statute of limitations could help but  raises difficulties. Taxpayers could be burdened by having to keep  records longer. IRS officials also had concerns in certain  circumstances, about relying on the extended statute of limitations  provided by the AJCA for undisclosed listed transactions.
Some revenue agents said that establishing a penalty on non-material  advisor promoters who do not provide investor lists within 20 business  days could help. Promoters who view their products as legitimate  might quickly provide a list to avoid this penalty. This penalty might  not prompt promoters who hide their transactions because they would  not pay any penalty or they believe they can escape detection. The new  penalty could be limited to those meeting the definition of a promoter  for IRC sections 6700 and 6701.
Another option for getting investor lists from promoters who are not  material advisors would be to lower the thresholds for material advisors,  which IRS had once considered. If these material advisor thresholds were  lowered, more promoters of reportable transactions could be required to  maintain lists and be penalized for not providing them. However, burdens  would increase for promoters with legitimate products, and those who  were not legitimate may still not be material advisors and may therefore  avoid the requirement.
section_title: Abusive Transaction Penalty Assessments Increased after AJCA Implementation
paragraphs: The AJCA revised or added penalties to address abusive transactions. For  the revised penalties, their annual number and aggregate dollar amount of  penalty assessments increased at least part of the time since AJCA passage  in 2004. For example, starting in 2004, the AJCA changed a penalty  imposed by section 6700 on promoters of abusive tax shelters from a  maximum of $1,000 to 50 percent of the gross income from a promotion.  As a result, IRS assessed penalties over $1 million against some promoters.  Compared to 2004, the annual aggregate number and amount of penalty  assessments was higher through 2009, as figure 4 shows.
AJCA provisions revised two penalties for IRS’s use against abusive  transactions (see app. II for details). For example, one provision— creating IRC section 6662A—augmented the existing accuracy-related  penalty with an accuracy-related penalty for reportable transaction  understatements. From fiscal year 2005 through 2009, the number of  penalties and aggregate dollar amount generally rose each year.
The AJCA added or amended three reportable-transaction disclosure  penalties, applying to taxpayers in the first case and material advisors in  the others (see app. II for details).
A new penalty imposed by IRC section 6707A is for taxpayers who fail  to adequately disclose reportable transactions. Most of the penalty  assessments were for $100,000 or $200,000.
A new penalty imposed by section 6707 is for material advisors who  fail to adequately disclose reportable transactions. Compared to the  6707A penalty on taxpayers, fewer material advisors were penalized,  but most of their penalty amounts exceeded $1 million, resulting in  higher aggregate penalty amounts.
A penalty imposed by section 6708 is for material advisors who fail to  maintain investor lists or provide them to IRS within 20 business days  after the request. Most penalty assessments ranged from $740,000 to  $1.1 million.
Figure 5 shows the number and dollar amount of assessments for the first  two penalties for not adequately disclosing reportable transactions— section 6707A against taxpayers and section 6707 against material  advisors.
After IRS’s increased use of the enhanced penalty sanctions under the  AJCA, the Congress amended section 6707A, decreasing the penalty  amounts for some cases. Many small businesses had received penalty  assessments that exceeded the benefits gained through the transactions.  The Small Business Jobs Act of 2010 lowered the penalty amounts (see  app. II for changes). Because the 2010 law change was retroactively  effective for penalties assessed after December 31, 2006, adjustments on  many assessments were needed. IRS officials said that they adjusted 898  closed cases as well as about 100 cases with penalty assessments that  were still open as of February 2011.
section_title: Conclusions
paragraphs: Because ATATs have been a long-standing, ever-changing, and often a  hidden problem for IRS, much activity in this area is left to IRS’s judgment.  For the same reasons, no set of actions taken by IRS would completely  eliminate the problem. IRS has shown vigilance in pursuing ATATs with a  number of programs and offices trying to attack the problem from  different perspectives.
While measuring the impact of IRS’s efforts is challenging, having more  information on the results of its enforcement efforts such as why  investigations were closed without penalties or injunctions would better  inform IRS management when making judgments about program  effectiveness and resource allocation. In addition, if IRS improved the  consistency and accuracy of its tracking and reporting of both its ATAT  and non-ATAT examination results, the information could be more  meaningful to managers as well as to the Joint Committee on Taxation.
Further, more could be done to ensure compliance with disclosure  requirements by material advisors and taxpayers. If OTSA could verify that  it received all required disclosures and that the disclosures were complete,  IRS would have more information to determine whether the transactions  disclosed were appropriate. However, paper filing continues to be a  barrier in processing disclosures, and actions to have more disclosures  filed electronically would be beneficial.
In addition, IRS has generally been successful in obtaining required  disclosures and investor lists from material advisors. Promoters who do  not meet the statutory definition to be a material advisor face no  requirements to provide IRS with their list of investors within 20 business  days after IRS requested a list or no penalties for failing to do so. If IRS  started to monitor the timeliness of its receipt of requested investor lists,  IRS would be able to determine when actions are needed to obtain the lists  sooner. IRS also could consider taking steps to get the lists sooner.  Various administrative steps, such as not always having a summons in  hand when meeting a suspected promoter, slow IRS. Addressing such  concerns could help ensure that promoters and taxpayers are complying  with congressional intent in requiring provision of the investor lists and  better position IRS to ensure that taxes legally due to Treasury are paid.
section_title: Matter for Congressional Consideration
paragraphs: The Congress should consider instituting a penalty on non-material  advisor promoters for failing to provide investor lists to IRS within a  specified time period when requested, comparable to the 20-business-day  requirement for material advisors.
section_title: Recommendations for Executive Action
paragraphs: We recommend that the Commissioner of Internal Revenue take the  following ten actions:  1.  To focus resources on promoter investigations most likely to stop  abuse, establish a process to ensure that field office staff consistently  apply the recently created reason codes for closing investigations  without penalties or injunctions, and document how the results are  analyzed and used in decisions on investigations to start.  2.  To improve reporting on the results of examinations on ATAT issues, a.  require all divisions to supply similar, consistent results from  b.  separately track the tax amounts recommended, assessed, and  collected between ATAT issues and non-ATAT issues; and  c.  establish a process to review the accuracy of examination data  prior to its inclusion in future reports to the Joint Committee on  Taxation.  3.  To ensure that Forms 8886 filed with tax returns are also filed with  OTSA, after establishing a new indicator for paper and electronic tax  returns, establish a process to periodically check whether the filers  met their filing obligations with OTSA.  4.  To improve IRS’s next study of whether Form 8886 should be filed  electronically, identify how often filers already use computers to  prepare these forms.  5.  To ensure material advisor disclosure forms are filed, investigate why  partnerships and S corporations often did not file a form with OTSA  even though they reported on their tax returns that they filed the form  with IRS or had a requirement to file.  6.  To correct problems with its review of the completeness of disclosure  forms, ensure that OTSA establishes a new process to review  completeness and monitor its success.  7.  To monitor the timeliness of investor list receipts, comprehensively  track the elapsed days it takes for material advisors and non-material  advisors to provide the lists to IRS.  8.  To induce non-material advisors to provide investor lists to IRS within  a specified time, take steps such as requiring IRS staff to bring a  summons for an investor list to the first interview with a suspected  non-material advisor, and reevaluating the idea of lowering material  advisor dollar thresholds.
section_title: Agency Comments and Our Evaluation
paragraphs: We sent a draft of this report to the Commissioner of Internal Revenue for  comment. We received written comments on the draft from IRS’s Deputy  Commissioner for Services and Enforcement on April 29, 2011 (for the full  text of the comments, see app. III). IRS agreed that better data may lead to  better resource allocation decisions and improved ATAT enforcement  efforts. Of our ten recommendations, it fully agreed with seven, disagreed  with one (number 7), and partially agreed with two (numbers 8 and 2b).
In describing actions on the recommendations with which IRS had  agreements, the Deputy Commissioner stated that IRS would do the  following:    update the Internal Revenue Manual’s handling of reason codes for  surveying or discontinuing investigations and evaluate whether any of  the reason data collected warrant changing how investigations are  selected;  ensure that IRS uses the same databases and methodologies (such as  across IRS divisions) for public reporting on the examination results of  ATAT issues; develop criteria for consistently using IRS examination result data and  a consistent methodology for validating the data before they are  released (such as to the Joint Committee on Taxation);  establish a new indicator and a process to regularly review whether  filers met their disclosure obligations with OTSA;  improve its next study of whether Form 8886 should be filed  electronically by identifying how many Form 8886 filers use computers  to prepare the form;  test mismatches of partnership and S corporation information with  OTSA information to identify potentially unfiled forms; and  formalize procedures to identify, evaluate, and follow up on  incomplete disclosures.
IRS disagreed with our recommendation on comprehensively tracking the  elapsed time for any advisors to provide investor lists when IRS requests.  IRS commented that the information currently contained in individual case  files reflects when information has been requested and received, but that  resource and capability constraints may outweigh the benefits of capturing  this additional information on a systematic basis. We agree that costs and  benefits must be carefully weighed. In that regard, IRS’s data collection  would not have to be elaborate. For instance, SB/SE officials already send  data on the investor lists received to a central list keeper. These officials  also could send the dates when each list was requested and received to  that same office. In that way, SB/SE could see if the slowness in receiving  some lists that we found is prevalent across the division, and other  divisions could do the same thing. If the slowness is prevalent, IRS  officials would then have the information needed to make decisions on  whether IRS is doing all it can to quickly determine and address any harm  to the government. Finally, the data collection is possible in that we were  able to collect such data from some revenue agents on the timeliness of  investor lists received.
IRS partially agreed with our recommendation on two options for inducing  non-material advisors to provide investor lists within a specified time. It  did not fully agree with the first option. In lieu of requiring summonses to  be prepared for the first meeting with non-material advisors, IRS stated  that its Internal Revenue Manual would recommend that IRS agents  consider preparing summonses to use at initial meetings with possibly  problematic non-material advisors. We encourage IRS to track how often  IRS agents provide summonses at these meetings in the future and  whether their doing so expedites obtaining non-material advisor investor  lists. If IRS still finds obtaining the lists difficult after changing the  Internal Revenue Manual, we encourage it to take additional steps to  receive the lists more quickly. IRS agreed with the second option on  reevaluating whether lowering material advisor thresholds would be  useful. It said it would gather input to make that determination.
IRS also partially agreed with our recommendation that it separately track  the tax amounts recommended, assessed, and collected between ATAT  issues and non-ATAT issues. Although IRS agreed that tracking these  amounts by issue (rather than by case as is currently done) might provide  valuable information for management, it cited resource and capability  constraints in doing the tracking. Recognizing the value of tracking this  management information, IRS should explore approaches to leverage its  resources in order to provide more accurate and consistent data on the  results of its examinations. This can help better inform IRS and the  Congress about whether the ATAT examinations are an efficient use of  resources in producing desired impacts.
As agreed with your offices, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days from its  issue date. At that time, we will send copies to the Secretary of the  Treasury, the Commissioner of Internal Revenue, and other interested  parties. The report will also be available at no charge on GAO’s Web site at  http://www.gao.gov.
If you or your staff have any questions about this report, please contact me  at (202) 512-9110 or at whitej@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this report. Key contributors to this report are listed in appendix IV.
section_title: Appendix I: Additional Details about Scope and Methodology
subsections: section_title: Results of the Internal Revenue Service’s (IRS) Promoter Investigations, Investor Examinations, and Settlement Initiatives
paragraphs: The statistics we analyzed came from many sources. We obtained data  related to promoter investigations from the Lead Development Center’s  (LDC) database within IRS’s Small Business/Self-Employed division.  Information about examinations came from IRS’s Audit Information  Management System-Computer Information System (A-CIS). IRS collected  information on settlement initiatives from initiative participants  throughout the organization.
To obtain information on why promoter investigations were either  discontinued or surveyed by IRS, we obtained documentation on these  investigations from LDC for fiscal year 2009. LDC received this  documentation, which provided the reasons the promoter investigations  were discontinued or surveyed, from examiners who performed the  investigations. Of 130 investigations that were either discontinued or  surveyed, we analyzed documentation on 97 investigations. We could not  analyze the remaining 33 investigations because either LDC did not receive  the documentation or the documentation was incomplete. From our  analysis of the 97 investigations, we identified the reasons these  investigations were either discontinued or surveyed.
section_title: Results of IRS’s Implementation of the Abusive Tax Avoidance Transaction (ATAT) Disclosure and Sanction Provisions Enacted in the American Jobs Creation Act of 2004 (AJCA)
paragraphs: To evaluate the results of IRS’s implementation of the AJCA, we selected  those sections of the act for which IRS had data on the disclosures and  penalties. We used data from different sources. We obtained ATAT  disclosure information from the reportable transaction and material  advisor databases kept by the Office of Tax Shelter Analysis (OTSA) and  penalty information from IRS’s Enforcement Revenue Information System  (ERIS). Criteria we used to evaluate the AJCA’s results included whether  (1) OTSA received all the reportable transaction and material advisor  forms it should have, (2) submitted reportable transaction disclosure  forms met OTSA’s standard for completeness, (3) IRS received investor  lists from material advisors within 20 business days of the time requested,  and (4) the AJCA’s introduction of new penalties and penalty amounts  increased the annual number and aggregate dollar amount of ATAT  penalties assessed.
To determine if IRS’s requirement for material advisor disclosures to be  filed with OTSA was met, we tested the extent for partnership and S  corporation tax returns. The returns we tested were in the IRS Statistics of  Income (SOI) division’s samples of partnership and S corporation tax  returns for 2007, the last year for which we had information during our  SOI work. These returns had a line item asking taxpayers if they had  disclosed, or needed to disclose, information about material advisors. For  those answering “yes,” we confirmed whether OTSA’s material advisor  database showed them filing a material advisor form from the time the  AJCA was enacted through much of 2010. After discovering that the  database often showed no material advisor forms filed, we followed up  with OTSA.
To determine how much time elapsed from when IRS requested lists of  investors with non-material advisor promoters until when it received  them, we used an IRS spreadsheet provided in August 2010 of open  investigations for which IRS had received lists. This spreadsheet showed  investigations being conducted by 90 investigators. We used this  spreadsheet to pinpoint IRS investigators from whom we could collect  information, rather than to project to a universe of investigators or  investigations. From the spreadsheet, we selected the 11 investigators with  the most open investigations. We selected another 20 investigators  randomly. We also asked to meet with all of the selected investigators in  groups to ask general questions about their impressions of how easy or  hard it was to obtain the lists. We met with or received written answers  from 27 investigators.
At our instruction, IRS sent each of the selected investigators a template  asking for the dates on which investor lists were requested and received  for each investigation. Fourteen investigators provided dates on when  investor lists were requested and received from promoters who were not  identified as tax return preparers. We excluded preparers because they are  required to submit copies of tax returns or the names of taxpayers for  whom they prepared tax returns to IRS when requested.
section_title: Reliability of Data from IRS Databases That We Used
paragraphs: We found the IRS databases we used to be reliable for the purposes of this  report. We had tested the reliability of A-CIS, ERIS, and SOI data for  previous reports, and we supplemented our knowledge through  interviews with IRS officials and through documentation review. For LDC  and OTSA databases, we reviewed documentation and interviewed IRS  officials. When we matched OTSA and SOI data, where appropriate, we  ran electronic checks and compared output to other information for  reasonableness purposes.
We conducted this performance audit from July 2009 through May 2011 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
section_title: Appendix II: Selected American Jobs Creation Act of 2004 Provisions Related to Tax Shelters
paragraphs: The American Jobs Creation Act of 2004 (AJCA) provided new or revised  tools related to what it called tax shelters. For example, it established  requirements for material advisors to disclose reportable transactions and  provide lists of their investors to IRS. It also added or revised penalties  and other sanctions, such as censures and injunctions. Information follows  on the AJCA-created or AJCA-changed sections of the Internal Revenue  Code (IRC) that we reviewed. Following that is similar information related  to amendments to title 31 of the United States Code, dealing with money  and finance.
subsections: section_title: IRC Section 6111— Disclosure of Reportable Transactions by Material Advisors
paragraphs: The AJCA provision amending section 6111 repealed the law on registering  tax shelters as defined therein and began requiring each material advisor  to describe any reportable transaction and its potential tax benefits on an  information return filed with IRS on a timely basis. The main information  return submitted by material advisors is the Material Advisor Disclosure  Statement (Form 8918), which superseded the Application for Registration  of a Tax Shelter (Form 8264). Table 3 shows the numbers of these forms  received from 2003 through 2009.
section_title: IRC Section 6112— Investor Lists
paragraphs: The AJCA provision amending section 6112 required that a material  advisor must keep a list identifying each person for whom the advisor  acted as a material advisor for a reportable transaction, and provide the  list to the Secretary when requested in writing. Table 4 shows the number  of lists that IRS’s Office of Tax Shelter Analysis (OTSA) requested from  2006 through 2009.
section_title: IRC Section 6501(c)(10)—Statute of Limitations for Undisclosed Listed Transactions
paragraphs: The AJCA amended section 6501 to extend the statute of limitations for  IRS to assess taxes related to undisclosed listed transactions. Generally,  the statute of limitations runs for 3 years after a tax return is filed or due,  whichever is later. As amended by the AJCA, the statute of limitations with  regard to listed transactions can extend beyond 3 years up to 1 year after  the earlier of the date that (1) the taxpayer discloses pursuant to section  6011, or (2) a material advisor satisfied the Secretary’s request for an  investor list under section 6112, including the name of the taxpayer in  question. According to IRS, it did not have systemic data on whether  assessments were made pursuant to section 6501(c)(10) because each  case is different and systemic information would be unreliable.
section_title: IRC Section 6662A— Accuracy-Related Penalty
paragraphs: The AJCA provision creating section 6662A augmented the existing 20  percent accuracy-related penalty of section 6662 with a new accuracy- related penalty for understated income from reportable transactions. If a  taxpayer disclosed a reportable transaction, the penalty would equal 20  percent of the understatement amount. If the taxpayer did not disclose the  transaction, the penalty would equal 30 percent of the understatement  amount. Table 5 shows an increase in the number of these penalties for  fiscal years 2005 through 2009 as well as in the number of abatements, or  reductions, of those penalties.
section_title: IRC Section 6700— Penalty on Promoters of Abusive Tax Shelters
paragraphs: The AJCA amended section 6700 to change the penalty amounts. Section  6700 imposes a penalty on persons who (1) organize or assist in the  organization of any entity, plan, or arrangement or (2) participate, directly  or indirectly, in the sale of any interest in an entity, plan, or arrangement.  For the section 6700 penalty to apply, the person must also make, furnish,  or cause another person to make or furnish (1) a gross valuation  overstatement (as defined therein) as to any material matter or (2) a  statement with respect to any tax benefit by reason of holding an interest  in the entity or participating in the plan or arrangement. Further, the  person to whom the penalty applies must know or have reason to know  that the statement is false or fraudulent in any material matter. Prior to the  enactment of the AJCA, the maximum penalty under section 6700 was  $1,000 for each activity (entity or arrangement). The AJCA changed the  penalty imposed on someone who knowingly makes a false statement (but  not to making a gross valuation overstatement) to 50 percent of the  person’s gross income from activity involving that statement. Table 6  shows penalties assessed under section 6700 from fiscal years 2004  through 2009.
section_title: IRC Section 6707— Penalty for Failing to Furnish Information Regarding Reportable Transactions
paragraphs: The AJCA provision amending section 6707 repealed the penalty for failure  to register tax shelters and established a new penalty. The new penalty  imposes on material advisors who fail to disclose reportable transactions  or who file false or incomplete information a $50,000 penalty, unless the  failure is related to a listed transaction; if the failure is related to a listed  transaction, the amount is increased to the greater of $200,000 or 50  percent (75 percent for an intentional failure or act) of the gross income  from the transaction. Table 7 shows assessments of this penalty from  fiscal years 2005 through 2009.
section_title: IRC Section 6707A— Penalty for Failure to Disclose Reportable Transactions
paragraphs: The AJCA provision creating 6707A established a penalty on any person  who fails to include with any return or statement any required information  on a reportable transaction. Generally, as amended by the Small Business  Jobs Act of 2010, the penalty is 75 percent of the decrease in tax shown on  the return resulting from the transaction, or which would have resulted if  the transaction complied with federal tax laws. The maximum penalty  amount is the same as the penalty amount prior to the change which is  $50,000 ($10,000 for an individual), except for listed transactions for which  the penalty is $200,000 ($100,000 for an individual). The minimum penalty  amount is $10,000 ($5,000 for an individual). Table 8 shows the  assessments for this penalty from fiscal years 2005 through 2009. However,  IRS was adjusting these amounts in light of the 2010 amendment.
section_title: IRC Section 6708— Failure to Maintain Investor Lists
paragraphs: The AJCA provision amending section 6708 modified the penalty for failing  to maintain the required lists by making it a time-sensitive penalty instead  of a per investor penalty. Thus, a material advisor required to maintain an  investor list who fails to make the list available upon written request to the  Secretary within 20 business days after the request will be subject to a  $10,000 per day penalty. Table 9 shows assessments for this penalty from  fiscal years 2005 through 2009.
section_title: IRC Section 7408— Enjoin Specified Conduct
paragraphs: The IRC authorizes civil actions to enjoin anyone from promoting abusive  tax shelters or aiding or abetting tax liability understatements. The AJCA  expanded this rule so that an injunction could be sought to enjoin a  material advisor from engaging in specific conduct subject to penalty  under (1) section 6707, failure to file an information return for a reportable  transaction, or (2) section 6708, failure to maintain or to furnish within 20  business days of the Secretary’s written request a list of investors for a  reportable transaction. According to the Lead Development Center (LDC),  it does not track injunctions specifically under section 7408. Table 10  shows the number of injunctions that LDC obtained regardless of IRC  section from fiscal years 2003 through 2009.
section_title: Title 31, Section 330— Practice before the Department of the Treasury
paragraphs: Before the AJCA, the Secretary was already authorized to suspend or  disbar from practice before the department someone’s representative who  was incompetent, was disreputable, violated rules regulating practice  before the department, or with intent to defraud, willfully and knowingly  misled or threatened the person being represented or who might be  represented. The AJCA provision related to this section expanded the  sanctions the Secretary could impose for these matters in two ways. First,  it expressly permitted censure as a sanction. Second, it allowed imposing a  monetary penalty as a sanction as long as the penalty did not exceed the  gross income from the relevant conduct. The penalty could be in addition  to or instead of any suspension, disbarment, or censure of the  representative. According to Treasury’s Office of Professional  Responsibility (OPR), OPR was already censuring before the AJCA was  enacted. The act clarified OPR’s authority. Table 11 shows the number of  OPR censures in fiscal years 2003 through 2009. OPR officials said OPR  had not assessed any monetary penalties.
section_title: Title 31, Section 5321—Penalty on Failure to Report Interest in Foreign Financial Accounts
paragraphs: Before the AJCA, citizens, residents, or persons doing business in the  United States could be penalized if they willfully did not keep records and  file reports when they made a transaction or maintained an account with a  foreign financial entity. The AJCA added a civil penalty of up to $10,000  that could be imposed on anyone violating the reporting requirement,  whether willfully or not. The AJCA also increased the prior-law penalty for  willful behavior to the greater of $100,000 or 50 percent of the amount of  the transaction or account. Table 12 shows the penalties imposed under  section 5321 from 2003 through 2009.
section_title: Appendix III: Comments from the Internal Revenue Service
section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Ralph Block and Thomas Short,  Assistant Directors; Virginia A. Chanley; Laurie C. King; Lawrence M. Korb;  Karen V. O’Conor; Ellen M. Rominger; Lou V. B. Smith; Andrew J.  Stephens; and James J. Ungvarsky made key contributions to this report.