According to IRS, during the mid to late 1990’s, abusive tax schemes reemerged across the country. The use of abusive tax shelters, anti- taxation arguments, abusive tax schemes, and frivolous returns last peaked in the 1980’s. IRS characterizes an abusive tax scheme as any plan or arrangement created and used to obtain tax benefits not allowable by law. Schemes run from simple to very complex, from clearly illegal to those carefully constructed to disguise the illegality of the scheme. Furthermore, users of schemes can range from those believing their position is correct to those who knowingly but willfully file incorrect tax returns. Schemes can be based on improper use of domestic and foreign trusts, inflated business expenses and deductions, falsely claimed tax credits and refunds, and various anti-tax arguments. Some schemes are created by tax professionals such as accountants, lawyers, and paid tax preparers, or by groups and individuals. Tax schemes are offered to taxpayers using various means, including conferences or seminars, publications, advertisements, and the Internet. Others are promoted by word-of-mouth. Abusive tax schemes that are generally used by individuals fall into four major categories. For the first two of these, frivolous returns and frivolous refunds, taxpayers submit a tax return that either states an argument that IRS can readily identify as frivolous, or a return with characteristics IRS has identified as reflecting a frivolous argument. For the other two types of schemes, abusive trusts and offshore compliance strategies, taxpayers’ returns are less likely to reveal use of a clearly abusive tax scheme. These schemes generally use any number of anti-tax arguments to incorrectly claim that income is exempt from taxation or that IRS otherwise lacks authority needed to tax income. These arguments have been well litigated in the courts and consistently ruled to be without merit. Examples include the following: Form 2555 Scheme: In this scheme, individuals file an IRS Form 2555, Foreign Earned Income, and claim that their income was not earned within the United States. This is also known as the “not a citizen” argument in which taxpayers file returns stating they are citizens of the “Republic of ” and not citizens of the United States, and thus, their income is not taxable. Section 861: Individuals using this scheme claim that under Internal Revenue Code section 861 income tax must only be paid on foreign income and, therefore, their income is not subject to tax or withholding. In these cases, taxpayers file a tax return and show a zero amount for wages. According to IRS, this argument has spread to some employers who are using it to avoid withholding and paying payroll- type taxes on their employees. According to IRS, credit and refund abusive tax schemes are designed to substantially reduce taxes or create a refund for the taxpayer, generally by claiming eligibility for a credit that does not exist or to which the taxpayer is not properly entitled. One such scheme that has received much attention is the Slavery Reparation Refund scheme. According to IRS, promoters circulate or publish information claiming African Americans are eligible for slavery reparations. Taxpayers claiming this credit generally enter a significant amount on their tax return as a credit that results in a taxpayer realizing a refund if not detected by IRS. A trust is a legitimate form of ownership, which completely separates asset responsibility and control from the benefits of ownership. As such, trusts are commonly used in matters such as estate planning. An abusive domestic trust scheme usually involves a taxpayer creating a trust that does not meet the Internal Revenue Code requirements that the assets and income of the trust not be subject to the control of the taxpayer. Once such an improper trust is established and the taxpayer has transferred business or personal assets to it, the scheme may involve further abuses, such as offsetting income of the trust by overstating its business expenses or including the taxpayer’s personal expenses—like a home mortgage—as an expense of the trust. The taxpayer will often use multiple entities such as partnerships, limited liability companies, or secondary level trusts that can be tiered or layered to mask the taxpayer’s continued ownership or control of the trust’s income or assets. Abuses that involve foreign locations can take a wide array of forms and attempt to use a number of techniques to improperly avoid paying taxes. One common technique is simply to use foreign locations to add another level of complexity in obscuring the true ownership of assets or income and thus obfuscating whether taxes are owed and by whom. Use of foreign locations, for instance, can be combined with use of trusts to make unraveling the true ownership of assets and income more difficult for IRS. According to IRS, criminals long have used offshore schemes to disguise the true nature of their enterprise and the resulting income. Promoters of abusive tax schemes have, according to IRS, increasingly devised schemes that in some fashion involve transferring income or title to assets to foreign locations. Often foreign locations are selected because they are tax havens with little or no taxation on income in their jurisdiction, have privacy rules that help schemers hide what they are doing, or have other characteristics favorable to carrying out the schemes. According to IRS, once such transfers are established, income is often repatriated back to the U.S. owners through loans, credit cards, or debit cards. By using complex transactions and multiple entities, the individuals using these schemes attempt to hide their income and avoid potential tax liabilities. According to IRS’s fiscal year 2003-2004 Small Business and Self-Employed (SB/SE) Division Strategic Assessment Report, abusive tax schemes represent a rapidly growing risk to the tax base. IRS estimates the potential revenue loss from these schemes to be in the tens of billions of dollars annually. According to an IRS official, to make accurate estimates in this area of noncompliance is difficult. For one reason, the nuances and types of schemes are constantly changing and evolving, particularly in the areas of abusive trusts and offshore compliance. Also, IRS’s detection of schemes is challenging. Trust schemes, in particular, often involve multiple entities that are vertically layered or tiered in an attempt to disguise the true ownership of the income or assets of the trust. The difficulty in determining the significance of offshore compliance is also exacerbated because these types of schemes generally use tax haven countries to disguise the transactions and prevent IRS from routinely collecting tax-related information on transactions. Despite the difficulties in accurately estimating the significance of abusive tax schemes, IRS provided us with estimates in four major scheme areas— Frivolous Returns, Frivolous Refunds, Abusive Domestic Trusts, and Offshore Schemes. According to IRS, its estimates were made in February of 2002 and were derived from information gathered during tax return processing and examination activities and from the work of IRS’s Criminal Investigation, the law enforcement arm of IRS. According to an IRS official, these estimates were derived from tax year 2000 information, the last full year for which data were available. IRS’s estimates are as follows: Frivolous returns: about 62,000 taxpayers with associated tax amounts approximating $1.8 billion. Frivolous refunds: about 105,000 taxpayers with associated tax amounts approximating $3.1 billion. Abusive domestic trusts: about 65,000 taxpayers with tax losses approximating $2.9 billion. Offshore schemes: about 505,000 taxpayers with tax losses ranging from $20 billion to $40 billion. IRS’s estimates for the numbers of taxpayers and taxes in connection with frivolous returns and refunds, although not precise, likely have less uncertainty than its estimates of the numbers of taxpayers and taxes at risk in connection with abusive domestic trusts and offshore schemes. IRS’s estimates for frivolous returns and refunds are based in large part on returns and refund claims that IRS has identified while processing tax returns and has addressed by pulling the associated returns and notifying the taxpayers that their returns contained errors that need to be corrected. Thus, in these cases, IRS has a fairly direct basis for counting the number of taxpayers involved and the amount of tax involved. Furthermore, because IRS has pulled these returns from processing, in general, improper refund claims have not been paid out, and IRS is pursuing collection of the proper amount of tax when taxpayers have failed to pay the full amount owed. In contrast, although taxpayers using domestic trusts and offshore schemes may file tax returns, those returns alone seldom provide enough information for IRS to determine whether an abusive scheme was used. Therefore, IRS’s estimates of the numbers of taxpayers and the taxes at risk for the domestic trust and offshore scheme categories generally rely on limited numbers of cases that have been examined or investigated, on intelligence obtained in the course of normal tax administration and Criminal Investigation activities, and on IRS officials’ professional judgments. Recognizing that offshore transactions are a significant factor in offshore schemes, IRS has been taking steps concerning the use of credit/debit cards issued by offshore banks to U.S. taxpayers. Although having an offshore credit card is not illegal, IRS believes that some U.S. taxpayers are using such cards to evade U.S. taxes. In October 2000, a federal judge authorized IRS to serve “John Doe” summonses on American Express and MasterCard to obtain limited information on U.S. taxpayers holding credit cards issued by banks in several tax haven countries. On the basis of information received from MasterCard, IRS identified about 235,000 accounts issued through 28 banks located in 3 countries. IRS’s ongoing analysis of these data leads it to estimate that between 60,000 and 130,000 U.S. customers are associated with these 235,000 accounts. In part because MasterCard is estimated to have about 30 percent of this market, IRS estimates that there could be 1 to 2 million U.S. citizens with credit/debit cards issued by offshore banks. However, this is a very preliminary estimate. IRS officials believe this estimate may be reduced because, among other things, a portion of these accounts may not be associated with abusive tax schemes. By comparison, only about 117,000 individual taxpayers indicated that they had offshore bank accounts in tax year 1999.