It is perfectly legal for U.S. taxpayers to hold money offshore. It is illegal, however, for a taxpayer to not disclose substantial offshore holdings, to not report income earned in the United States and “hidden” through offshore arrangements, and to not report income earned offshore to IRS on the taxpayer’s tax return. If U.S. taxpayers own an offshore business such as a foreign corporation, they are required to disclose that holding to IRS on their tax return. When applied to abusive transactions, 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. When referring to a financial institution, “offshore” refers to a financial institution that primarily offers its services to persons domiciled outside the jurisdiction of the country in which the financial institution is organized. Abusive offshore schemes are often accomplished through the use of limited liability corporations (LLC), limited liability partnerships (LLP), international business corporations (IBC), and trusts, foreign financial accounts, debit or credit cards, and other similar instruments. According to IRS, the schemes can be complex, often involving multiple layers and multiple transactions used to hide the true nature and ownership of the assets or income that the taxpayer is attempting to hide from IRS. IRS has multiple programs and techniques used to select potentially noncompliant tax returns for examination. One source is a computer model designed to predict returns that, if audited, would be most likely to result in additional taxes owed. Other sources that prompt an examination include referrals from inside or outside IRS, information from third parties, and indications of fraud or noncompliance from other audits. Once IRS has identified a return for an examination, the classification process begins. Classification is the process of determining whether a return should be selected for examination, what issues should be examined, and how the examination should be conducted. IRS guidance on classification states that classification should be conducted by an experienced examiner. Examination is the accumulation of evidence for evaluating the accuracy of the taxpayer’s tax return. Examiners gather facts to correctly determine a taxpayer’s tax liability. Evidence can include the taxpayer’s testimony and books and records as well as the examiner’s own observations and documents from third parties. Methods for accumulation of evidence include analytical tests, documentation, inquiry, inspection, observation, and testing. IRS procedures call for examiners to pursue an examination to the point where a reasonable determination of correct tax liability can be made. In turn, examiners prepare audit reports, which should contain all information necessary to ensure a clear understanding of the adjustment, if any, and document how the tax liability was computed. These reports serve as the basis for assessment actions. An assessment records the taxpayer’s liability due. IRS examinations are generally of one of three types—correspondence, office, or field. The simplest examinations usually cover one to two tax issues handled by a lower-graded examiner through correspondence. More complex examinations are done by meeting with taxpayers or their representatives in IRS offices. The most complex examinations are done through revenue agent field visits to taxpayer locations. Only about 16 percent of all IRS examinations from 2002 through 2005 were conducted through field examinations, but 98 percent of offshore examinations were of this type. About three-fourths of nonoffshore examinations are handled through correspondence. IRS does not classify every return that is filed, nor does it examine every case file that is classified, even if IRS determines that examining the tax return would likely yield an assessment of additional taxes owed. Figure 1 provides a notional representation of the process of taking the over 130 million individual income tax returns that were filed in fiscal year 2004 through the steps that lead to audits of a much smaller number of those returns. In most cases, the law gives IRS 3 years from the date a taxpayer files a tax return to complete an examination and make an assessment of any additional tax. For example, if a taxpayer filed a tax return on April 15, 2000, IRS had until April 15, 2003, to finish any examination of that return and make an assessment of additional taxes owed by the taxpayer. This statute of limitations for assessments is in effect for all examinations with exceptions allowing longer periods for certain taxpayer actions or omissions such as fraud or substantial understatement of gross income (in excess of 25 percent of the amount of gross income stated on the return). Taxpayers may also waive the 3-year assessment limitation through written consent. In general, it takes longer for IRS to identify and examine tax returns involving abusive offshore transactions than IRS needs in nonoffshore cases because of the added complexity of examining offshore transactions. Where IRS is able to complete examinations involving abusive offshore transactions, they generally result in larger assessments than other types of examinations. IRS has policies in place to avoid violating the statute of limitations, and IRS enforcement personnel told us that these policies, in conjunction with the longer time needed to complete offshore examinations, mean some cases are never opened in the first place while others are not fully worked because the time allowed under the current statute is running out. As a result, they said, overall assessments for offshore cases are lower than they would be if IRS had more time to work these cases. IRS officials told us that cases involving offshore tax evasion present special, time-consuming challenges that other types of cases do not. Tax evasion, both domestic and offshore, often involves schemes with many layers of deception. IRS officials told us that for domestic tax evasion, revenue agents are able to issue summonses to domestic financial institutions to uncover the layers of deception the taxpayer created to hide the source and existence of the funds. In offshore cases, IRS generally does not have summons power over offshore financial institutions, and is often unable to determine the owner of an offshore account or business, or determine the source of the funds. Even in cases where IRS is able to determine information about offshore funds, an IRS manager told us that this process of discovery is much more time consuming than for nonoffshore cases. Unlike much nonoffshore tax evasion, most possible offshore tax evasion cases are not discovered through IRS’s computerized analysis of tax returns, but rather through investigations of promoters of offshore schemes. Officials told us that several divisions of IRS forward leads on the promoters of offshore schemes they discover to revenue agents, who develop the cases in order to discover the extent of the promoter’s use of offshore schemes. This process takes far longer than computer analysis- based methods of identifying potential noncompliance. After developing information that a promoter of offshore schemes illegally sold schemes to help taxpayers avoid their tax liability, IRS can refer that information to the Department of Justice, which can then file a complaint in the United States District Court requesting the court to issue an injunction against the promoter. In some cases, the injunction will compel the promoter to disclose the clients who purchased the scheme. IRS officials told us that it can take years to get a client list from a promoter and, even with a client list, there is still much work that IRS needs to do before the clients of the offshore schemes can be audited. For example, IRS officials told us that they may only get limited information about the clients of offshore promoters, and often that information is limited to a name and perhaps the city and state where the client lives, so considerable time may be spent finding the individuals listed by the promoter. Time spent developing information on a return before putting it into the queue for examination shortens the time available to close the examination before the 3-year civil statute of limitations expires. Table 1 compares the median number of days spent in development for offshore and nonoffshore examinations from 2002 to 2005. As shown in the table, the median offshore case took 184 more calendar days than the median nonoffshore case to move from filing to examination. Comparing just field examinations, which constituted over 98 percent of offshore examinations in fiscal years 2002 through 2005, the difference in median development time was 96 days. Some examinations lead to additional examinations of the same taxpayer’s returns, such as when a revenue agent identifies noncompliance on one return and then reviews prior year returns looking for the same problem, or when a taxpayer files a new return while an examination is underway. To avoid overstating development time, this comparison includes only the number of days between the start of the examination and the filing date of the last return filed before the examination began. Once offshore cases are developed and moved into examination, the examinations take longer than nonoffshore cases. Considering all types of examinations together, the median offshore examination took 90 more days than the median nonoffshore examination. Considering field examinations alone, the median offshore field examination was 70 days longer than the median nonoffshore field examination, as shown in table 2. IRS officials told us that this is due to examination complexity and the difficulty of identifying and obtaining information from foreign sources. The total time that elapses between a return being filed and IRS’s closing of the examination of that return is referred to as total cycle time and provides another type of comparison between offshore and nonoffshore cases. As shown in table 3, the median offshore examination took almost 500 more calendar days overall to close than the median nonoffshore examination, a 126 percent difference. The median offshore case took 82 percent of the statute time versus 36 percent for nonoffshore cases. Considering just field examinations, the median cycle times for offshore and nonoffshore examinations were closer in length, but the median offshore examination was still 194 days longer, a difference of 28 percent. About half of all offshore examinations resulted in a recommended assessment of additional taxes due compared to approximately 70 percent of nonoffshore examinations. While less frequent, assessments from all types of offshore examinations—correspondence, office and field—had a median that was nearly 3 times larger than from nonoffshore examinations. Considering just field examinations, recommended assessments from offshore examinations also had a median that was much larger than nonoffshore examinations, though by a smaller margin, as shown in table 4.