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Reference Number: 2001-30-159
This report has cleared the Treasury Inspector General for
disclosure review process and information determined to be restricted from
has been redacted from this document.
September 13, 2001
MEMORANDUM FOR COMMISSIONER, LARGE AND MID-SIZE BUSINESS DIVISION
FROM: (for) Pamela J. Gardiner /s/ Gordon C. Milbourn III
Deputy Inspector General for Audit
SUBJECT: Final Management Advisory Report - The Strategy for Curbing Abusive
Corporate Tax Shelter Growth Shows Promise but Could Be Enhanced by Performance
This report presents the results of our review of whether the processes in
the Internal Revenue Service’s (IRS) Large and Mid-Size Business (LMSB)
Division effectively address Abusive Corporate Tax Shelters.
In summary, the IRS has made progress towards curbing abusive corporate tax
shelter growth. An important first step taken was to establish a central office,
the Office of Tax Shelter Analysis (OTSA) in the LMSB Division. The head of
the OTSA has collaborated with the LMSB Division design teams in developing
a multi-faceted strategy that shows promise in effectively curbing abusive
corporate tax shelter growth through a centralized coordination of deterrence,
detection, and resolution activities.
A critical part of the overall approach in deterring shelters is the expanded
disclosure rules, which require participants to provide statements to the OTSA
describing potentially abusive transactions. In addition, financial service
providers and others involved in selling potentially abusive corporate tax
shelters have to maintain lists of the corporations that buy their shelters
and make them available to the OTSA for inspection. Because cleverly constructed
abusive shelters can be difficult to detect if not properly disclosed, the
OTSA is creating databases from disclosure statements and other sources to
give them the capability of cross-checking reported tax information. To oversee
and approve resolution actions that could include initiating examinations or
imposing penalties on shelter participants, a high-level steering committee
has been formed. Since many different IRS offices could be involved in resolving
an abusive shelter, the steering committee will be a key control for ensuring
that shelter participants are treated consistently throughout the country and
that abusive transactions are distinguished from ones designed to legally reduce
While the LMSB Division’s approach for curbing abusive corporate tax
shelter growth shows promise, it could be enhanced by performance measures.
Anecdotal evidence gathered initially by the IRS, Department of the Treasury,
and others indicated that the government could be at risk of losing $10 billion
annually through abusive corporate tax shelters. However, the Division has
yet to develop reliable information needed to ensure that this initial estimate
is valid and that it can form a baseline against which progress can be measured.
Initial actions to "size-up" the problem involved surveys of the
LMSB Division managers and examiners. The survey results are now being used,
in part, to develop and test a complex mathematical formula that the LMSB Division
believes will provide a more precise baseline estimate of the abusive tax shelter
Management Response: In commenting on a draft of this report, the Commissioner,
LMSB Division, concurred with our recommendations and agreed to take efforts
to implement them. Management’s complete response to the draft report
is included as Appendix IV.
Copies of this report are also being sent to IRS officials who are affected
by the report recommendations. Please contact me at (202) 622-6510 if you have
any questions or Gordon C. Milbourn III, Assistant Inspector General for Audit
(Small Business and Corporate Programs), at (202) 622-3837.
Table of Contents
Abusive corporate tax shelters are sophisticated transactions often developed
by tax accountants, lawyers, and other financial service providers and sold
to corporations as a way to lower their tax liabilities. Even though the transactions
may comply with the tax law, they typically lack a legitimate business purpose
other than reducing taxes. One example of a shelter involved a lease agreement
structured so one party could deduct expenses currently and report income later.
The mismatch between current deductions and delayed income generated significant
The Department of the Treasury, the Congress, and some tax professionals have
serious concerns about the corrosive effect abusive corporate tax shelters
could have on the tax system. In reports issued in 1999, the Department of
the Treasury and the Congress Joint Committee on Taxation indicated abusive
shelters could be costing the government billions of dollars in lost revenue
annually. Besides the revenue loss, there is even greater concern that abusive
corporate tax shelters could ultimately undermine voluntary compliance by reducing
the trust responsible taxpayers have in the integrity of the tax system.
In response to the concerns, the Internal Revenue Services (IRS) Large
and Mid-Size Business (LMSB) Division formalized a strategic plan in Fiscal
Year (FY) 2000 to strengthen the IRS ability to deal with abusive corporate
tax shelters. The LMSB Division considers its plan a critical element needed
to achieve the IRS core goals of applying the tax law with integrity
The LMSB Division serves approximately 224,000 business taxpayers with over
$5 million in assets. The Division annually examines approximately 20,000 tax
returns, including 450 to 575 of the nations largest corporations.
This review is part of our FY 2001 emphasis areas focusing on the LMSB Divisions
strategic initiatives. We performed work in the Divisions National Headquarters.
Our review was conducted between October 2000 and March 2001 and was performed
in accordance with the Presidents Council on Integrity and Efficiencys
Quality Standards for Inspections. Detailed information of our objective, scope
and methodology are presented in Appendix I. Major contributors to the report
are listed in Appendix II.
Progress Made Towards Curbing
Abusive Corporate Tax Shelter Growth
The IRS has made progress towards curbing abusive corporate tax shelter growth.
In February 2000, the IRS created a central office, the Office of Tax Shelter
Analysis (OTSA) in the LMSB Division to coordinate and guide efforts at curbing
the growth of abusive corporate tax shelters. While not all processes for dealing
with abusive corporate tax shelters have been finalized, some important steps
have been taken. As of April 2001, the head of the OTSA had collaborated with
the LMSB Division design teams and had developed and begun implementing a multi-faceted
approach for combating abusive corporate tax shelters through a centralized
coordination of deterrence, detection, and resolution processes.
Processes to deter abusive corporate tax shelters
A critical part of the overall strategy is deterring the promotion of abusive
corporate tax shelters through expanded disclosure rules. The rules especially
target shelters that are being promoted or sold for fees in excess of $100,000.
The rules were announced with the creation of the OTSA and involve three elements:
Registering Shelters. The shelter promoters are required to apply
for a unique registration number for each tax shelter though the IRS Ogden
Submission Processing Center. The registration number enables the IRS to
trace transactions that it considers were structured primarily for tax
avoidance or evasion.
Keeping investor lists and promotion material. The promoters are
also required to keep a list of the corporations that buy their shelters
as well as the promotional material used to sell the shelter. Both the
list and promotional material need to be available for inspection by the
IRS when requested.
Providing disclosure statements. The corporations that purchase
certain transactions the IRS considers potentially abusive are required
to outline the transaction in a statement that is provided to the OTSA
and attached to their tax returns. Generally, these are transactions that
can reduce tax liabilities by more than $5 million in a year or are one
of the transactions the IRS has published in guidelines as "listed
In addition to publishing guidelines, another visible component of the overall
strategy to deter participation in abusive corporate tax shelters has been
through outreach and education efforts. LMSB Division officials have participated
in numerous information-sharing meetings with professional associations such
as the American Institute of Certified Public Accountants and the American
Processes to detect abusive corporate tax shelters
To date, abusive corporate tax shelters have been primarily identified through
tips from concerned professionals or in IRS examinations that found irregularities
on tax returns. While tips and examinations have identified and addressed some
abusive corporate tax shelters, government officials are concerned that more
cleverly constructed abusive corporate tax shelters are going undetected. To
address this concern, the OTSA is creating databases from registration statements,
disclosure statements, and other sources to give it the capability of cross-checking
reported tax information.
In addition, the LMSB Division has developed a comprehensive plan that will
enable the IRS to begin accepting corporate returns and supporting schedules
electronically in FY 2003. Once the electronic return information is received,
it can be organized into databases to allow a greater capability for identifying
potentially abusive transactions. Currently, the IRS transcribes into its databases
only about 150 line items out of the thousands that could be reflected on a
corporate return. According to LMSB Division officials, this limited data does
not make it feasible to conduct the detailed analysis needed for identifying
potentially abusive shelters electronically, particularly ones that are cleverly
Processes to resolve abusive corporate tax shelters
To oversee and approve resolution actions, a high-level steering committee,
the Tax Shelter Promoter Committee, has been formed. The Committee is comprised
of IRS executives and officials from the IRS Office of Chief Counsel
and Criminal Investigation function. The Committee is a key control for ensuring
that taxpayers are treated consistently throughout the country and that abusive
transactions are distinguished from ones designed to legally reduce taxes.
The planning documentation we reviewed indicates that resolution techniques
vary depending on whether the IRS is dealing with a promoter of or investor
in an abusive corporate tax shelter. Severe penalties under Internal Revenue
Code Section 6700 will likely be pursued in promoter cases since they can be
considered a root cause of the problem. Penalties could result in assessing
up to $75 million or higher against a promoter.
To resolve investor cases, a less aggressive approach is being considered.
The plans call for contacting investors through "soft notices" and
asking them to review their records and make corrections, if necessary. To
make the correction, an investor may need to file an amended return. If the
investor does not comply with the request, an examination will be initiated
to disallow the abusive transaction and assess additional taxes and penalties.
Reliable Baseline Information Would Provide
a Stronger Foundation for the Strategy
Concerns that the government may be at risk of losing $10 billion annually
through abusive corporate tax shelters began to surface in 1999 from sources
inside and outside of the government. However, the LMSB Division does not have
reliable information needed to ensure whether this estimate is accurate and
to measure the success of the abusive corporate tax shelter strategy. Without
establishing this baseline now, the Divisions ability to measure the
success of its strategy to curb the growth of abusive tax shelters would be
To add perspective to the $10 billion that some estimate the government may
be losing annually through shelters, we compared it to the total additional
liabilities recommended in all IRS field and office examinations in FY 1998,
1999, and 2000. On average, IRS revenue agents and tax auditors examined 474,131
individual, corporate, and other returns and recommended additional liabilities
of $17.9 billion. In FY 2000, the $10 billion estimated annual loss from shelters
was 68 percent of the total additional liabilities recommended in all examinations.
Figure 1 shows a comparison between the $10 billion estimated loss from shelters
to the total additional liabilities recommended from all IRS examinations in
FY 1998, 1999, and 2000.
Figure 1 was removed due to its size. To see Figure 1, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.
The IRS recognized that it needed a starting point for estimating the extent
of the abusive corporate tax shelter problem. The initial actions to "size-up" the
problem involved surveys of field personnel. In October 1999, field personnel
were sent questionnaires that solicited information to assist in determining
the loss of revenue and the extent of the corporate tax shelter problem. A
second survey was initiated a year later (October 2000) that involved all LMSB
Division field staff. The information collected from the surveys is now being
used, in part, to develop and test a complex mathematical formula that the
LMSB Division envisions will provide a more precise estimate of the corporate
tax shelter problem.
However, we found various methodology problems in how the surveys were performed
that raise questions about whether the survey results can be used successfully
in developing a reliable baseline measure. We compared the recommended methodology
for conducting surveys that is outlined in the IRS Guidelines for
Conducting Statistical Surveys to the methodology used to survey the field
personnel and found the following problems.
Low response rates to the 1999 and 2000 surveys limit the IRS ability
to rely on the results. Adequate consideration was not given to assigning
control numbers to the survey questionnaires or using other techniques to
minimize the number of no-responses that required follow-up. Participants
that do not respond are a major source of error that significantly reduces
the reliability of survey results. Because of the control limitations, the
IRS did not have the information that showed the actual number of field personnel
that received the surveys. To overcome some of the control limitations and
to estimate a response rate, we compared the number of respondents recorded
in the IRS databases to the number of field managers targeted for survey.
Our estimated response rate was less than 30 percent for each of the surveys
and would be lower if field personnel other than managers received a survey
Data from the 2000 survey was not always consistently collected. We
judgmentally selected for review 86 records in the database that contained
results from the 2000 survey and found inconsistencies in the data collected.
For example, some respondents projected potential tax liabilities related to
shelters to returns that were not under examination, and in some cases they
were not yet even filed. Other respondents limited the potential tax liabilities
to the returns that were under examination.
These conditions occurred because the survey preparers did not fully consider
the need for technical advice from subject matter experts like a statistician
trained in administering data gathering surveys. One LMSB Division official
told us he did not see how the IRS Guidelines for Conducting Statistical
Surveys applied to the surveys because they were not trying to build a
statistical model. Instead, the surveys were performed to determine the field
inventory of abusive corporate tax shelters.
We are not questioning the need to move forward with implementing the strategy
given the widespread concern over abusive corporate tax shelters. However,
the LMSB Division needs reliable baseline information as a starting point for
measuring the success of the strategy and improving its ability to manage and
oversee implementation of the strategy.
We discussed this report with LMSB officials on July 20, 2001. They advised
us that the LMSB Division has initiated a formal study to (1) estimate the
potential tax revenue impact attributed to abusive corporate tax shelters,
(2) define characteristics and behavioral triggers of abusive shelters, and
(3) develop an abusive corporate issue identification system. According to
officials the study will involve additional surveys of LMSB Division managers
- The Commissioner, LMSB Division, should take steps to lay a better foundation
for the abusive corporate tax shelter strategy by obtaining a more precise
estimate of the shelter problem. This could be accomplished by coordinating
with statisticians or other experts in the LMSB Divisions newly established
Office of Strategy and Research and Program Planning, in:
Assessing the effect the results from the 1999 and 2000 surveys have on
current efforts to measure the extent of the shelter problem. In light
of the problems identified in the surveys, the assessment should document
the rationale behind any decision to continue using the results in ongoing
Designing and conducing a statistical survey of LMSB Division managers
and examiners using valid data collection procedures.
Managements Response: The Commissioner, LMSB Division, recognizes
the need to conduct a formal study to determine the effect abusive corporate
tax shelters have on the LMSB Divisions corporate tax population. Among
other actions, the OTSA and the LMSB Divisions Office of Strategy, Research,
and Program Planning, established a research team that will:
Performance Measures Are Needed to
Estimate the potential tax revenue effect attributed to abusive corporate
Define characteristics and behavioral triggers of abusive shelters.
Develop an abusive corporate issue identification and classification system.
Determine Whether the Office of Tax Shelter
Analysis Is Successful
Once reliable baseline information is established for the strategy, the next
step would be to develop effective performance measures for tracking the progress
the OTSA makes against the baseline. LMSB Division Design Teams established
the charter and detailed plans that led to the vision, organizational structure,
core functions and activities, roles and responsibilities, and key processes
that the OTSA is using today.
We reviewed the Design Teams charters and detailed plans and concluded
that adequate consideration was not given to developing or recommending performance
measures needed to track whether the OTSA is meeting its objectives. The absence
of performance measures for the OTSA raises concerns that the LMSB Division
managers may have difficulty effectively managing the implementation and operation
of its strategy to curb the growth of abusive corporate tax shelters.
Both the General Accounting Office (GAO) and the Treasury Inspector General
for Tax Administration have previously reported that establishing performance
measures is central to the success of any significant undertaking. Successful
undertakings rely heavily upon performance measures to achieve objectives,
quantify problems, evaluate alternatives, allocate resources, track progress,
and learn from mistakes. The GAOs Executive Guide: Effectively Implementing
the Government Performance and Results Act indicates that a combination
of output and outcome measures is appropriate for assessing performance.
Output measures generally provide information about an undertaking of program
actions taken, in terms such as the number of actions completed, or the number
completed in a specified time frame. For example, an output measure for the
OTSA could show the number of abusive tax shelters identified within a specified
time frame. Outcome-oriented measures show program results achieved related
to effectiveness, efficiency, or impact. An outcome measure for the OTSA could
include the tax dollars saved through its actions.
2. The Commissioner, LMSB Division, should develop performance measures for
the OTSA that will allow managers to better target problem areas, highlight
successes, evaluate alternatives, and track whether the OTSA is achieving desired
Managements Response: The LMSB Division Offices of Pre-filing
and Technical Guidance, and Performance, Quality, and Innovation will jointly
work to develop appropriate performance measures in FY 2002.
Detailed Objective, Scope, and Methodology
The objective of this review was to assess the effectiveness of the Large
and Mid-Size Business (LMSB) Divisions plans for curbing abusive corporate
tax shelter growth. We performed work at the LMSB Divisions National
Headquarters in Washington, D.C. Our work was focused in the following areas:
Interviewed management officials from the LMSB Divisions Tax Shelter
Analysis Design Team, the Office of Pre-filing and Technical Guidance,
the Office of Appeals, and the Office of Chief Counsel to obtain information
about the development, implementation, and measurement of the abusive corporate
tax shelter strategy.
Analyzed planning and other documents prepared by Tax Shelter Analysis
Design Teams to obtain information about the core processes designed for
the Office of Tax Shelter Analysis, including the tax shelter registration
process, disclosure statement process, and hot-line process.
Reviewed documentation from the General Accounting Office and prior Treasury
Inspector General for Tax Administration audits that addressed the importance
of establishing performance measures for significant undertakings.
Reviewed relevant documents and reports prepared by the Department of
the Treasury, the Congress Joint Committee on Taxation, the Internal
Revenue Service (IRS), and outside tax professionals to obtain estimates
on the amount of dollars the government may be at risk of losing from abusive
corporate tax shelters.
Compared the methodology used to survey LMSB Division managers and examiners
to the IRS Guidelines for Conducting Statistical Surveys to
assess whether the survey results could be relied upon as a baseline measure
of the abusive corporate tax shelter problem.
Assessed the effect that unreliable survey results could have on the LMSB
Divisions Office of Strategy, Research, and Program Plannings
efforts to develop a more precise estimate of the abusive corporate tax
Evaluated whether Tax Shelter Analysis Design Teams adequately considered
work processes for deterring, detecting, and resolving shelters in a manner
that would ensure taxpayers are treated consistently and that abusive transactions
are distinguished from ones designed to legally reduce taxes.
Assessed the level of outreach and education activity the LMSB Division
has been involved with by reviewing Internal Revenue Bulletins, expanded
tax shelter disclosure rules, and presentations given to internal and external
Analyzed IRS Table 37, Examination Program Monitoring, to determine the
total additional liabilities recommended from all audits in Fiscal Years
1998, 1999, and 2000.
Major Contributors to this Report
Gordon C. Milbourn III, Assistant Inspector General for Audit (Small Business
and Corporate Programs)
Philip Shropshire, Director
Frank Dunleavy, Audit Manager
Stanley M. Pinkston, Senior Auditor
Lawrence R. Smith, Senior Auditor
Jean Kao, Auditor
William Tran, Auditor
Report Distribution List
Chief Counsel CC
Deputy Commissioner N:DC
Deputy Commissioner, Large and Mid-Size Business Division LM
Director, Performance, Quality, and Innovation, Large and Mid-Size Business
Director, Pre-Filing and Technical Guidance, Large and Mid-Size Business Division
Director, Strategy, Research and Program Planning, Large and Mid-Size Business
Director, Legislative Affairs CL:LA
Director, Office of Program Evaluation and Risk Analysis N:ADC:R:O
National Taxpayer Advocate TA
Office of Management Controls N:CFO:F:M
Commissioner, Large and Mid-Size Business Division LM
Managements Response to the Draft
The response was removed due to its size. To see the response, please go to
the Adobe PDF version of the report on the TIGTA Public Web Page.