The type and extent of individual taxpayers’ illegal offshore activity varies. Several Factors May Facilitate the Use of Offshore Jurisdictions to Avoid Paying Taxes

Limited transparency regarding U.S. persons’ financial activities in foreign  jurisdictions contributes to the risk that some persons may use offshore  entities to hide illegal activity from U.S. regulators and enforcement  officials. Finally, financial advisors often facilitate abusive transactions by enabling  taxpayers’ offshore schemes. IRS Faces Significant Challenges in Identifying the Nature and Extent of Offshore Noncompliance

IRS has several initiatives that target offshore tax evasion, but tax evasion  and crimes involving offshore entities are difficult to detect and to  prosecute. As noted earlier, individual U.S. taxpayers and corporations generally are  required to self-report their foreign taxable income to IRS. In  addition, when self-reporting does occur, the completeness and accuracy  of reported information is not easily verified. Given the characteristics of offshore evasion, IRS examinations that  include offshore tax issues for an individual can take much longer than  other examinations. Specifically, our past work has shown that from 2002  through 2005, IRS examinations involving offshore tax evasion took a  median of 500 more calendar days to develop and examine than other  examinations. The amount of time required to complete offshore  examinations is lengthy for several reasons, such as technical complexity  and the difficulty of obtaining information from foreign sources. Because of the 3-year statute of  limitations on assessments, 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 them at all,  despite evidence of likely noncompliance. In  testimony before Congress, the Commissioner of Internal Revenue has  said that in cases involving offshore bank and investment accounts in bank  secrecy jurisdictions, it would be helpful for Congress to extend the time  for assessing a tax liability with respect to offshore issues from 3 to 6  years. At a more fundamental level, jurisdictional limitations also make it  difficult for IRS to identify potential noncompliance associated with  offshore activity. Under the QI program, foreign  financial institutions voluntarily report to IRS income earned and taxes  withheld on U.S. source income, providing some assurance that taxes on  U.S. source income sent offshore are properly withheld and income is  properly reported. The previously discussed case of Swiss bank UBS provides a stark  example of the QI program’s vulnerabilities. This is a work of the U.S. government and is not subject to copyright protection in the  United States.
Why GAO Did This Study

Much offshore financial activity by individual U.S. taxpayers is not illegal, but numerous schemes have been devised to hide the true ownership of funds held offshore and income moving between the United States and offshore jurisdictions. In recent years, GAO has reported on several aspects of offshore financial activity and the tax compliance and tax administration challenges such activity raises for the Internal Revenue Service (IRS). To assist the Congress in understanding these issues and to support Congress's consideration of possible legislative changes, GAO was asked to summarize its recent work describing individual offshore tax noncompliance, factors that enable offshore noncompliance, and the challenges that U.S. taxpayers' financial activity in offshore jurisdictions pose for IRS. This statement was primarily drawn from previously issued GAO products.

What GAO Found

Individual U.S. taxpayers engage in financial activity involving offshore jurisdictions for a variety of reasons. When they do, they are obligated to report any income earned in the course of those activities. They are also required to report when they control more than $10,000 in assets outside of the country. However, much of this required reporting depends on taxpayers knowing their reporting obligations and voluntarily complying. Some taxpayers do not comply with their income and asset reporting obligations. Limited transparency, the relative ease and low cost of establishing offshore entities, and an array of financial advisors can facilitate tax evasion. IRS's Qualified Intermediary program has helped IRS obtain information about U.S. taxpayers' offshore financial activity, but as the recent case against the large Swiss bank UBS AG underscores, the program alone is insufficient to address all offshore tax evasion. Earlier, GAO had recommended changes to improve QI reporting, make better use of reports, and enhance assurance that any fraudulent QI activity is detected. IRS examinations that include offshore tax issues can take much longer than other examinations. GAO's past work has shown that from 2002 through 2005, IRS examinations involving offshore tax evasion took a median of 500 more calendar days to develop and examine than other examinations. The amount of time required to complete offshore examinations is lengthy for several reasons, such as technical complexity and the difficulty of obtaining information from foreign sources. However, the same statute of limitations preventing IRS from assessing taxes or penalties more than 3 years after a return is filed applies to both domestic and offshore financial activity. 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 them at all, despite evidence of likely noncompliance. In testimony before Congress, the Commissioner of Internal Revenue has said that in cases involving offshore bank and investment accounts in bank secrecy jurisdictions, it would be helpful for Congress to extend the time to assess a tax liability with respect to offshore issues from 3 to 6 years.