Offshore Tax Havens: Sequestration Damages IRS Battle With Tax Evasion

04/30/2013 07:29 am ET | Updated Apr 30, 2013

WASHINGTON -- Special IRS amnesty programs for illegal offshore tax evasion have brought billions of dollars to the U.S. government and opened a wealth of new information about criminal tax fraud for investigators, according to a new report by the Government Accountability Office. But paltry IRS funding -- compounded by budget cuts required by sequestration -- is undermining its ability to combat tax cheating.

Since 2009, the IRS has recovered roughly $5.5 billion in unpaid taxes and penalties through amnesty programs targeting Swiss banking customers. These programs are being efficiently and effectively managed, according to the GAO, but an independent investigation by Sens. Carl Levin (D-Mich.) and Tom Coburn (R-Okla.) estimated that the government still loses at least $100 billion a year from offshore tax evasion.

"That's probably the tip of the iceberg," said Rebecca Wilkins, senior tax policy counsel at Citizens for Tax Justice.

While there are legal ways for the wealthy to reduce their taxes by shifting cash abroad, the GAO report exclusively examined simple, criminal offshore tax evasion, in which money his hidden from the IRS in low- or no-tax countries like Switzerland or the Cayman Islands. Through tax amnesty programs, the IRS has developed critical new information about the banks where people illegally hide money, and the accountants and financial advisers who help engineer illegal tax schemes. The IRS has the authority to ask these financial professionals for client names, and use them to open new investigations.

The amnesty programs also have exposed new demographic information on tax criminals, revealing two basic categories of offshore tax criminals: ultra-wealthy families who pass down their accounts to future generations, and everyone else.

According to the GAO report, 49 percent of the total penalties assessed on offshore tax dodgers by the IRS were culled from only 378 cases -- just 6 percent of the 10,439 cases that the IRS has processed in full. The high penalty amount is an inevitable result of the scope of the tax evasion for these accounts -- all featured unpaid tax bills of at least $5 million.

Of those 378 cases, 47 percent involved offshore accounts that had been inherited from another family member. Nearly one-fourth of all the $5.5 billion in tax penalties the IRS has collected since the inception of its amnesty program has come from inherited wealth.

Because of the IRS budget squeeze, the agency finds it difficult to take advantage of the new data. The IRS currently audits about 1 percent of tax returns, according to Wilkins, making it easy for fraudulent or fishy returns to go undetected.

"The IRS just doesn't have the resources to investigate and prosecute all of the fraud that's going on," Wilkins said. "It's the same problem with corporate disclosures. One company might have a 58,000-page filing. Nobody has time to go through all of that material."

The IRS budget has been cut steadily over the past few years as political pressure to cut government spending has increased. That spending problem has grown more severe under the budget cuts associated with sequestration.

Last week, Acting IRS Commissioner Steve Miller sent a memo to all of the agency's employees notifying them that they would be furloughed without pay for seven days this summer, according to a copy of the memo obtained by The Huffington Post. The IRS declined to comment for this article.

"Congress cutting the IRS budget is so short-sighted," Wilkins said. "This is obviously an area where you can spend money to make money. "They could bring in a lot more money by staffing up."

For years, criminal offshore tax evasion was a low-risk way to lower U.S. taxpayer tabs, since the bank secrecy laws in Switzerland and the Cayman Islands are strict. But in 2008, a whistleblower from Swiss banking giant UBS presented the IRS with the names of thousands of clients who were hiding money from the U.S. government with his company to avoid paying American taxes. The resulting caseload overwhelmed already-overburdened IRS staff, prompting the agency to offer these tax cheats a deal: Anyone who confessed to illegally stashing money abroad could avoid jail time and publicity by agreeing to pay all back taxes owed, plus a 20 percent penalty. For some accounts deemed "small" -- less than $75,000 in unpaid taxes -- the IRS imposed lower penalty fees.

Thousands of wealthy Americans decided to take the deal rather than risk prison. To date, more than 30,000 taxpayers have sought amnesty through the program. More than 10,000 of those claims have been fully processed.

The GAO flagged an additional 10,000 taxpayers who may have filed "quiet disclosures" without catching the IRS' attention. In a quiet disclosure, taxpayers officially acknowledge the existence of an offshore account without owning up to unpaid back taxes or mandatory penalties that would be imposed by the amnesty program. A quiet disclosure is relatively risky -- taxpayers give the IRS more information to bring a tax evasion case. But for many taxpayers, the certainty of saving money in the short-term is still worth the risk of getting caught.

The scope of criminal tax evasion is likely far broader than what the GAO cited and some of the wealthy taxpayers who took amnesty may not have disclosed other criminal accounts in jurisdictions outside of Switzerland.

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