Examinations involving offshore tax evasion take much more time to develop and complete than examinations of other types of returns, but when offshore examinations are completed, the resulting median assessment is almost three times larger than for all other types of examinations. However, because of the 3-year statute, the additional time needed to complete an offshore examination means that IRS sometimes has to prematurely end offshore examinations and sometimes chooses not to open an examination at all, despite evidence of likely noncompliance. Some offshore examinations exhibit enforcement problems, such as technical complexity, which are similar to those where Congress has granted a statute change or exception in the past. In a separate report being publicly released today, we suggest that Congress lengthen the statute of limitations for cases involving offshore activity. IRS generally uses the term “offshore” to mean a country or jurisdiction that offers financial secrecy laws in an effort to attract investment from outside its borders. IRS examinations, both offshore and nonoffshore, are generally of one of three types—correspondence, office, or field. The most complex examinations are done through revenue agent field visits to taxpayer locations, that is, field examinations. Most offshore examinations from 2002 through 2005 were of this type. Generally, unless a taxpayer’s tax return involves fraud or a substantial understatement of income, or unless the taxpayer agrees to an extension, the statute of limitations for IRS to assess additional taxes is 3 years from when IRS receives the taxpayer’s tax return. Taking an examination past the statute of limitations date may result in disciplinary action against the responsible revenue agent and his or her manager. Comparing offshore and nonoffshore examinations, IRS examination data from fiscal years 2002 through 2005 showed that it takes IRS longer both to develop a potential offshore examination case after a return is filed and to conduct the examination itself. The median of offshore case total cycle time—the time that elapses between a return being filed and IRS’s closing of the examination of that return—was almost 500 calendar days longer than for nonoffshore cases, a 126 percent difference. Offshore examinations also required significantly more direct examination time, with an average of 46 hours spent directly on offshore examinations and 12 hours on nonoffshore examinations. IRS officials told us that the longer time needed to complete offshore examinations is because of the inherent difficulty in identifying and obtaining information from foreign sources, often dilatory and uncooperative tactics on the part of taxpayers and their representatives, and technical complexity. About half of all offshore examinations resulted in a recommended assessment of additional taxes due compared to approximately 70 percent of nonoffshore examinations. While fewer offshore examinations resulted in assessments, the median assessment of all types of offshore examinations was nearly three times larger than for nonoffshore examinations. Although assessments were larger, the greater number of hours of direct examination time meant that assessment dollars per hour of offshore direct examination time were about half that of nonoffshore examinations—$1,084 per hour from offshore examinations and $2,156 from nonoffshore examinations. IRS created guidance for continuing offshore examinations past the 3-year point. Subject to management approval, agents can carry on the examination past the 3-year point based on their judgment that, given additional time, they will ultimately prove that the examination met one of the criteria necessary for IRS to make an assessment after the 3-year statute date has passed. All of the examinations allowed to extend past the statute date under this guidance represent a gamble on the part of IRS that the examination will ultimately meet one of the exceptions to the statute and an assessment will be allowed under the law. IRS records show that 1,942 offshore examinations were taken past the 3-year statute period from fiscal years 2002 through 2005. IRS ultimately made assessments on 63 percent of these examinations and these assessments were significantly higher than assessments from all other types of examinations, with a median assessment of about $17,500 versus about $5,800 from offshore examinations that were closed within the 3-year statute of limitations. The median assessment for all nonoffshore examinations that went past the statute date was about $4,900 versus about $2,900 from all nonoffshore examinations closed within 3 years. IRS databases do not allow systematic analysis of the approximately 700 offshore examinations that did not result in an assessment, so we do not know if these were accurate returns or if the agent discovered tax evasion but it did not rise to the level of fraud or substantial understatement of income. Revenue agents and managers told us that because IRS has only 3 years from the time the taxpayer files a tax return, and offshore cases take longer than nonoffshore cases to identify and develop, some case files are not opened for examination because insufficient time remains under the statute to make the examination worthwhile. They added that, in order to avoid violating the statute, they will often choose case files to examine with more time remaining under the 3-year statute of limitations over case files that have less time remaining and with more likely or more substantial possible assessments. Similarly, IRS revenue agents and managers sometimes close cases without examining all issues rather than risk taking the examination past the statute period, losing revenue, and facing disciplinary action. Congress has lengthened or made exceptions to the statute in the past. For example, Congress changed the statute in 2004 to provide IRS with an additional year to make assessments in the case of unreported listed transactions. Since many offshore schemes exhibited enforcement problems similar to those of unreported listed transactions, it follows that a similar statute extension could be granted for certain offshore transactions. IRS officials and individuals from the tax practitioner and policy communities told us of both advantages and disadvantages of an exception to the statute for taxpayers involved in offshore financial activity. For example, an advantage was increased flexibility for IRS to direct enforcement resources to egregious cases. A disadvantage was lack of closure for taxpayers. In our report discussed earlier, we suggest that Congress make an exception to the 3-year civil statute of limitations assessment period for cases involving offshore activity. In e-mail comments on a draft of our report, IRS expressed agreement that a longer statute makes sense and should enhance compliance. For tax year 2003, withholding agents reported that individuals and businesses residing abroad received about $293 billion in income from U.S. sources. The QI program provides IRS some assurance that tax is properly withheld and reported to IRS. However, a low percentage of U.S source income flows through QIs. In addition, although QIs are subject to external reviews, the auditors conducting these reviews are not required to follow up on indications of fraud or illegal acts. Further, IRS does not make effective use of the data it receives from withholding agents to ensure that withholding agents perform their duties properly. To address our objectives for the QI program, we reviewed various IRS documents and interviewed IRS and Department of the Treasury (Treasury) officials and private practitioners involved in the development and implementation of the QI program. We also reviewed various studies and reports on foreign investment and banking practices. A GAO investigator created a shell corporation and opened a bank account for that corporation to test the due diligence exercised by withholding agents. We also analyzed IRS data on U.S. source income that flowed overseas for tax years 2002 and 2003. The qualified intermediary data were reported by withholding agents and edited by IRS, and do not include an unknown amount of activity that was unreported. We determined that these data were sufficiently reliable for the purposes of describing the qualified intermediary program by (1) performing electronic testing for obvious errors in accuracy and completeness and (2) interviewing agency officials knowledgeable about the data, specifically about how the data were edited. We reviewed the auditing requirements contained in the QI agreement and other standards, such as the U.S. Government Auditing Standards and the international standard on agreed-upon procedures (AUP) and visited IRS’s Philadelphia Campus, which is responsible for processing the information returns submitted by QIs. Money is mobile and once it has moved offshore, the U.S. government generally does not have the authority to require foreign governments or foreign financial institutions to help IRS collect tax on income generated from that money. In 1913, the United States enacted its first legislation establishing that U.S. persons and nonresident aliens were subject to withholding at source before the investment income leaves U.S. jurisdiction. Subsequent legislation made withholding applicable to dividends and certain kinds of bond income earned by nonresident aliens, foreign corporations, foreign partnerships and foreign trusts and estates. The Internal Revenue Service issued a comprehensive set of withholding regulations for nonresident aliens in 1956. These regulations have been changed over the years to reflect statutory changes or perceived abuses by taxpayers. To attract foreign investment, the tax rules were further adapted to exclude several types of nonresident alien capital income from U.S. taxation, such as capital gains from the sale of personal property, interest income from bank deposits and “portfolio interest,” which includes U.S. and corporate debt obligations. The latter exemption helps finance the U.S. national debt by offering a U.S. tax free rate of return for foreigners willing to invest in U.S. bonds. Most of the U.S. source income flowing offshore likely is paid to nonresident aliens but some may be paid to U.S. persons. The income may be paid directly to nonresident aliens located offshore, for example when a company pays dividends to a foreign stockholder, or may flow through one or more U.S. or foreign financial intermediaries, such as banks or brokerage firms. Whether this income paid to nonresident aliens is subject to U.S. tax and, if so, how much depends on a number of factors, including the type of income and whether the recipient is a resident of a country with which the United States has negotiated a lower tax rate. If U.S. source income is subject to U.S. tax, the payor of that income has to report information about the recipient and the type and amount of income to IRS, and in some cases would be required under U.S. law to withhold the taxes due from the recipient.