Many legitimate reasons explain why a business owner (or  owners) may choose to use a network of related entities to conduct  operations. IRS has charged SAT ESC with coordinating  information about tax shelter schemes—including those that might involve  networks—that individual operating divisions identify. IRS Suspects Networks Pose a Growing Tax Evasion Risk but Faces Barriers in Addressing the Risk through Its Traditional Enforcement Efforts

		IRS Does Not Know the Magnitude of Network Tax Evasion, but Has Observed an Increase in Risk Factors for Such Evasion

IRS does not have an estimate of the total amount of revenue lost through  network tax evasion because of cost and complexity constraints. IRS’s Traditional Enforcement Programs Are Not Designed to Detect Network Tax Evasion

IRS’s programs for addressing network-related tax evasion include its  examinations (or audits) in which IRS examiners analyze taxpayers’  records to ensure that the proper tax was reported. IRS traditionally has conducted examinations on a return-by-return basis,  beginning with a single tax return in a particular tax year as the unit of  analysis and examining other tax returns connected with the original  return, if necessary, in what can be called a bottom-up approach. Single tax year examinations. IRS’s Recent Efforts to Better Detect and Pursue Network Tax Evasion Show Promise, but Opportunities Exist for Additional Progress

		IRS Is Developing Programs and Tools Intended to Help Address Network Tax Evasion

IRS has been creating specific programs and tools that address network  tax evasion more directly than its traditional examination approach. Global High Wealth Industry (GWHI)

Under GHWI, IRS identifies certain high-wealth individuals and then  examines each individual’s network. A variety of  entities could comprise a network, which could be under the purview of  different IRS divisions. The efforts are  supported by upper management, offer new analytical approaches that  more directly address network tax evasion, and attempt to cut across IRS’s  divisional boundaries and databases. For example, the table notes the lack of  agencywide strategy and goals for IRS’s various network efforts that are  spread throughout the agency. As already discussed, the population of  networks is not known, networks can be complex, and IRS does not know  which programs and tools will be most effective. The strategy should  include:    assessing the effectiveness of network analysis tools, such as yK-1;    determining the feasibility and benefits of increasing access to existing  IRS data, such as scanning additional data from Schedule K-1, or  collecting additional data for use in its network analysis efforts;    putting the development of analytical techniques and tools that focus  on networks as the unit of analysis, such as GraphQuery, on a specific  time schedule; and    deciding how network efforts will be managed across IRS, such as  whether a core program team or management group is needed. IRS also generally agreed with our  recommendations to establish an IRS-wide strategy with goals, ensure that  staff understand the capabilities of IRS’s network tools, and establish a  more formal way for IRS staff to collaborate as new network tools are  developed and implemented. Our recommendation is that IRS develops  a strategy. GAO staff who made major contributions to this report are  listed in appendix V.

Appendix I: Objectives, Scope, and Methodology

The objectives of this report were to (1) describe what the Internal  Revenue Service (IRS) knows about network tax evasion and how well  IRS’s traditional enforcement efforts address network tax evasion and (2)  assess IRS’s progress in addressing network tax evasion and opportunities,  if any, in making further progress. We also interviewed relevant IRS  officials and staff. We also interviewed IRS auditors about their  work. The criteria for selection of these studies  were similar to those used in selecting experts. Four types of entities that  IRS recognizes that also can form networks are corporations,  partnerships, trusts, and individuals. Trusts can be connected to other entities in a network in several ways. The IRS will look at this issue. It may not be possible nor appropriate to manage  network compliance activity centrally.
Why GAO Did This Study

A taxpayer can control a group of related entities--such as trusts, corporations, or partnerships--in a network. These networks can serve a variety of legitimate business purposes, but they also can be used in complex tax evasion schemes that are difficult for the Internal Revenue Service (IRS) to identify. GAO was asked to (1) describe what IRS knows about network tax evasion and how well IRS's traditional enforcement programs address it and (2) assess IRS's progress in addressing network tax evasion and opportunities, if any, for making further progress. To do this, GAO reviewed relevant documentation about IRS programs and interviewed appropriate officials about those programs and IRS's plans for addressing such tax evasion. GAO also interviewed relevant experts and agency officials in developing criteria needed to perform the assessment.

What GAO Found

IRS views network-based tax evasion as a problem but does not have estimates of the associated revenue loss in part because data do not exist on the population of networks. IRS does know that at least 1 million networks existed involving partnerships and similar entities in tax year 2008. IRS also knows that many questionable tax shelters and abusive transactions rely on the links among commonly owned entities in a network. IRS generally addresses network-related tax evasion through its examination programs. These programs traditionally involve identifying a single return from a single tax year and routing the return to the IRS division that specializes in auditing that type of return. From a single return, examiners may branch out to review other entities if information on the original return appears suspicious. However, this traditional approach does not align well with how network tax evasion schemes work. Such schemes can cross multiple IRS divisions or require time and expertise that IRS may not have allocated at the start of an examination. A case of network tax evasion also may not be evident without looking at multiple tax years. IRS is developing programs and tools that more directly address network tax evasion. One, called Global High Wealth Industry, selects certain high-income individuals and examines their network of entities as a whole to look for tax evasion. Another, yK-1, is a computerized visualization tool that shows the links between entities in a network. These efforts show promise when compared to GAO's criteria for assessing network analyses. They represent new analytical approaches, have upper-management support, and cut across divisions and database boundaries. However, there are opportunities for more progress. For example, IRS has no agencywide strategy or goals for coordinating its network efforts. It has not conducted assessments of its network tools, nor has it determined the value of incorporating more data into its network programs and tools or scheduled such additions. Without a strategy and assessments, IRS risks duplicating efforts and managers will not have information about the effectiveness of the new programs and tools that could inform resource allocation decisions. Among other items, GAO recommends that IRS establish an IRS-wide strategy that coordinates its network tax evasion efforts. Also, IRS should assess its network programs and tools and should evaluate adding more data to its current tools. IRS generally agreed with these recommendations and noted additional organizational changes the agency is making that will address networks.