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Hearing of the Senate Finance Committee - Tax Issues Related to Ponzi Schemes and an Update on Offshore Tax Evasion Legislation

CHAIRED BY: SENATOR MAX BAUCUS (D-MT)

WITNESSES: DOUGLAS SHULMAN, COMMISSIONER, INTERNAL REVENUE SERVICE; MICHAEL BROSTEK, DIRECTOR OF TAX ISSUES, GOVERNMENT ACCOUNTABILITY OFFICE; WILLIAM JOSEPHSON, ESQ., FRIED, FRANK, HARRIS, SHRIVER & JACOBSON, LLP

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SEN. BAUCUS: (Sounds gavel.) The hearing will come to order. Sophocles wrote, "Things gained through unjust fraud are never secure." Today we consider two kinds of unjust frauds. Today we look for ways to help honest taxpayers become just a little more secure. Today we examine the tax consequences of Bernard L. Madoff scheme to defraud investors, and we consider ways to crack down on the efforts of offshore tax entities to defraud the U.S. government of the taxes that they owe.

Last December, during one of our nation's most severe financial crises, authorities uncovered perhaps the nation's largest case of financial fraud. On December 11th, Bernard L. Madoff was arrested after revealing that for two decades he had been running a Ponzi scheme that involved more than $60 billion. A court-appointed trustee found that, incredibly, Madoff's firm had conducted absolutely no trading for at least 13 years -- 13 years of false earnings and 13 years of no trades. Last week Madoff pleaded guilty to 11 counts of fraud, money laundering, perjury and theft. Those charges carry with them maximum sentences that add up to 150 years.

Senators Schumer, Cantwell and Menendez requested that we hold a hearing on the tax consequences for these victims and today IRS Commissioner Doug Schulman will explain how these victims can process their losses on their tax returns. We expect the commissioner to discuss issues like theft loft, phantom income and fraudulent conveyance. He will also discuss his effort to combat another type of fraud. He will discuss outlines of fraud. He will discuss outlines of potential legislation designed to stem overseas tax evasion.

In the last Congress the Finance Committee held two hearings on overseas tax evasion. In a May 2007 Finance Committee hearing, GAO testified about the Qualified Intermediary program and offshore tax evasion. Qualified intermediaries are a key element of the government's overseas tax enforcement system. Qualified intermediaries are financial institutions that serve as our nation's eyes and ears on the movement of U.S. funds overseas, but they don't work very well. The GAO determined that foreign corporations, set up by an American individual, perhaps in the Cayman Islands, may enable that individual to hide income tax behind the corporate veil.

And in July 2008, a Finance Committee hearing focused on the Cayman Islands, by the way, as an offshore tax evasion. I asked the GAO to travel to the Caymans and look at the Ugland House. That's that famous five-story building that the GAO testified has 18,587 tenants. Half of those tenants, about 9,000 of them, are reportedly Americans. The GAO reported the following findings related to the Cayman Islands -- just the Caymans: "U.S. taxpayers have reported 1,400 controlled foreign corporations in the Cayman Islands. Two- trillion dollars of bank assets are based there, 9,000 mutual funds, including hedge funds, and a hedge fund for every seven people on the island."

After the second hearing I decided it was time to do something about this, to do what we could to close that overseas tax gap. Some have estimated the overseas tax gap to total 50 (billion dollars) to $70 billion a year, reminding all of us that the tax gap is, again, taxes legally owed but not timely paid. Today we'll discuss legislative proposals intended to enhance the transparency of offshore activity. We will consider how we can give the IRS better tools to deter, detect and stop offshore noncompliance.

Among other proposals, here are three: The first would require entities transferring funds offshore, other than on behalf of publicly traded companies, to report to the IRS the amount and destination or account information of the funds transferred. This will give the IRS a trail of funds going offshore and it will help the IRS to deter and detect offshore noncompliance. The second proposal would extend the statute of limitations for tax returns with certain international transactions from three years to six years. This change would give the IRS more time to detect and examine often complicated offshore activity. And the third proposal would facilitate the IRS's ability to enforce compliance with the law's requirement for reports of foreign bank and financial accounts. The proposal would require entities to file these reports along with their tax returns.

As we look out at the deficit that we will be facing over the next few years, the importance of moving forward on the offshore tax evasion problem becomes all the more clear. We need to reclaim every dollar of taxpayer money that we can from these offshore tax evaders. President Obama's fiscal year 2010 budget proposes a robust effort aimed at curbing offshore tax evasion. While we wait for the details of his plan, it makes sense for us to move forward, nevertheless, on proposals that we think could do the job.

While we are on the topic of scans, I'm looking very closely at tax options that will reclaim the outrageous bonuses paid by AIG. The country is angry. Individual Americans are angry. I am angry. Four- and-a-half million Americans have lost their jobs. At least four-and- a-half million Americans in this recession have lost their jobs, and these people who are getting bonuses are getting multi-million-dollar bonuses while others are losing their jobs. It is just totally unfair. So we're looking at various ideas and I'll discuss them with committee members shortly.

And so we have to look for ways to address unjust fraud and do what we can to help fraud's victims. Let us try to help honest taxpayers become just a little more secure.

Senator Grassley.

SEN. CHARLES GRASSLEY (R-IA): Mr. Chairman, I'm going to just refer to one paragraph of my opening statement, put the rest in the record.

Some of the charities that invested in Bernie Madoff, including universities and those funded by Hollywood, would presumable have sophisticated advisors. This raises questions for me about whether the board members of these organizations were more interested in helping their friend than furthering charitable work. Mr. Josephson, who is here to testify, will probably appreciate that as well. His willingness to be here again today -- he's been before this committee before to discuss due diligence requirements for charities' trustees and boards of directors as well as other tax implications for board misconduct under Internal Revenue Service -- and then I would spend just a little bit of time thanking you for bringing up the AIG issue.

We're here to talk about Ponzi schemes, and I suppose every Ponzi scheme is different and AIG may not fall into that category, but it surely brings into question a lot of tax issues that we have in TARP, and the fact that in some cases income limitations apply and in some cases they don't, and the extent to which bonuses are affected of not affected. So I want to back you up on looking into that and doing what we can to make sure that these things don't happen in the future because from the standpoint of not understanding Ponzi schemes, after about seven or eight months of reading about AIG and trying to determine what happens, I'm not even sure we have a handle on exactly what happened. And in this case of this economic recession, caused by a lot of people taking chances and doing things that weren't very transparent, we've got to bring some transparency to this. So I appreciate that very much.

SEN. BAUCUS: Thank you, Senator, very, very much.

Now I welcome our witnesses. Our first is IRS Commissioner Doug Schulman. Thank you, Commissioner, for being here. Next we have the director of Tax Issues for the GAO, Michael Brostek. And, finally, we have the former assistant attorney general for the New York State Law Department's Charities Bureau, William Josephson. In the normal practice, all your statements will be included in the record and I ask you to speak for about five minutes. And we'll start with you, Commissioner.

MR. SCHULMAN: Thank you, Mr. Chairman, Ranking Member Grassley, members of the committee. I appreciate the opportunity to testify today about Ponzi schemes in general, which also will provide some guidance around the Madoff situation, as well as talking to you about IRS's efforts to detect and stop unlawful offshore tax avoidance.

Beyond the toll of human suffering, the Madoff case raises numerous issues for the victims of losses from Ponzi-type investment schemes. To help provide clarity in this very complicated matter, today the IRS is issuing two guidance items that will assist victims of all Ponzi schemes. Let me refer you to my written testimony, which has more details, and I'll make a few points about the guidance.

The first is a revenue ruling, which is the Treasury Department and the IRS's best legal interpretation regarding the tax treatments of losses in Ponzi schemes. Determining the amount and timing of tax deductions arising from Ponzi-type investment schemes is factually very difficult and depends on the taxpayer's prospect for recovering the lost money, and sometimes that can take years to determine.

The guidance we are issuing today clarifies that Ponzi losses are investment theft losses under the code and that the taxpayer may deduct all of the purported earnings on which the investor paid taxes as well as the cash invested in the Ponzi scheme. It also clarifies that the investment theft loss is not a normal casualty loss, and therefore is not subject to limitations that apply to non-investment type losses. This ruling should provide clarity and straightforward guidance to taxpayers.

In addition, we've issued a revenue procedure with the goal of making it as easy as possible for taxpayers affected by these schemes to avail themselves of the proper tax deductions. Key to the revenue procedure is providing a safe-harbor method of computing and reporting losses. The procedures goal, again, is to be helpful to taxpayers who are confronted with a very complex area of the law and difficult facts.

Mr. Chairman, I'm also pleased to briefly describe the unprecedented focus that the IRS has brought to detecting and bringing to justice those who unlawfully hide assets overseas to avoid paying tax. In today's economic environment where the federal government is necessarily running large deficits to restore economic growth, it's more important than ever that American citizens feel confident that individuals and corporations are playing by the rules and paying the taxes that they owe.

When the American public is confronted with stories of financial institutions helping U.S. citizens to maintain secret overseas accounts involving sham trusts to improperly avoid U.S. tax, they should be outraged, as am I, and as I know you are, but they should also know that the U.S. government is taking unprecedented measures and there's much more to come.

I can assure you that the president and the Treasury secretary are committed to taking aggressive action on offshore tax abuse. Over the next several months the administration intends to propose a series of legislative and enforcement measures to reduce U.S. tax evasion and avoidance. While I'm proud of the progress we have made since I became commissioner, we are only at the beginning. You should expect to see a multi-year effort of beefing up our resources and tools needed to address international tax abuse.

Since becoming commissioner I've made international issues a top priority. We actually discussed it at my confirmation hearing here a year ago of the Senate Finance Committee. I've increased the number of audits in this area and stepped up hiring of international investigators and experts. We have been steadily increasing pressure on offshore financial institutions that facilitate concealment of taxable income by U.S. citizens, and that pressure, I can assure you, will only increase.

The IRS investigations are getting results. The Justice Department recently signed a deferred prosecution agreement with a major Swiss bank, which involved the payment of $780 million. They are also continuing to pursue a lawsuit for a civil summons to get more bank accounts from that institution. Several so-called tax haven countries have pledged to reform bank secrecy laws, and just last week have agreed to comply with international standards for tax and data sharing. The IRS is also looking to improve information reporting and sharing.

Mr. Chairman, you referred to the Qualified Intermediary program, which gives us a line of sight to foreign financial institutions. We're looking to improve that program by increasing the type of information that those institutions must report about U.S. citizens, and also creating rules that insist better due diligence on accounts opened or maintained by qualified intermediaries. We're also exploring the increased use of and potentially more information reporting requirements around money being transferred in and out of the United States.

Mr. Chairman, I know that you're considering legislation designed to improve tax compliance with respect to offshore transactions. I appreciate all the support you've given to the IRS. I believe that the general direction of your legislation will help us combat offshore tax abuse. My staff and I are looking forward to working with you and other members of this committee on that legislation.

I want to thank you for the opportunity to testify and I'll look forward to answering your questions.

SEN. BAUCUS: Thank you very much, Commissioner. Sorry, my microphone wasn't on. Thank you, Commissioner. Mr. Brostek, you're next.

MR. BROSTEK: Mr. Chairman, Senator Grassley and members of the committee, thank you for inviting me to discuss our work related to individuals' use of offshore locations to evade taxes. My statement describes the characteristics of individuals found to have evaded tax and how they did so, describes factors that enable offshore noncompliance, and discusses challenges that offshore financial activities pose for IRS.

Taxpayers whose noncompliance involves offshore locations are a diverse group. Some have owed relatively small amounts of taxes, interest and penalties, but some have evaded millions in taxes on hundreds of millions of dollars in assets. Some taxpayers appear to have been inadvertently failing to pay their taxes, such as when they inherited money overseas but failed to report income earned on that money. Others have used very elaborate structures that served to hide their activities and thus appear to have been quite deliberate in their evasions.

Regardless, taxpayers' offshore noncompliance can be enabled by the limited transparency that is a hallmark of many offshore jurisdictions. Some offshore jurisdictions share very limited information about U.S. taxpayers with IRS, and those wishing to evade taxes can devise elaborate, sometimes multinational schemes to hide their activity. Due to the limited transparency of offshore investments and transactions, compliance for those with offshore activity relies on self-reporting. Years of IRS research have shown that when compliance is so heavily voluntary, taxpayers tend to be noncompliant.

Financial advisors may also facilitate many offshore schemes. Advisors may cater to a retail market, to conferences open to a very wide variety of individuals. Alternatively, advisors may target just those with very substantial income or assets. Either way, advisors can use relative ease and low cost when creating offshore accounts, companies, trusts, et cetera to help taxpayers hide their income.

These characteristics of offshore locations and activity make enforcement challenging. The complexity of offshore cases results in examinations with an offshore component taking much longer than normal examinations; that is, audits. For the period we studied, the median time between a return being filed and the completion of an offshore examination was almost 500 days longer than for all other examinations. Due to the three-year civil statute of limitations, IRS sometimes prematurely ends offshore examinations, even though declined cases may have more assessment potential than cases that are not near the statutory deadline. Congress has granted exceptions to the three- year statute in some situations, for instance when a taxpayer fails to report listed transactions. GAO suggests that Congress consider its statute extension for cases that do involve offshore activity.

To promote offshore compliance, IRS has established the Qualified Intermediary program, QI program, in the year 2000. The program does help ensure that U.S.-source income paid to foreign persons is properly taxed. U.S.-source income includes, for example, interest on U.S. and corporate bonds, stock dividends and rents. QIs are foreign financial institutions that contract with IRS to withhold U.S.-source income that they pay to their customers and to report certain information to IRS.

These QI program features should result in QIs being a better source of withholding decisions that U.S. withholding agencies. That is because QIs are overseas.

They are more likely to have direct contact with the foreign customers than U.S. withholding agents would and should be better able to judge whether customers are qualified for lower tax rates, such as under our treaties.

Second, QIs accept enhanced responsibility for ensuring customers qualify for lower taxes, such as using IRS-approved documents to identify their customers.

Finally, and importantly, QIs agree to have external parties review their accounts and procedures and report those results to the IRS. However, the recent deferred prosecution agreement for UBS Ag starkly shows that the program is an imperfect tool to thwart offshore compliance problems. Earlier we made several recommendations to improve the QI program. Perhaps most pertinent to today's hearing is our recommendation that IRS require QI's external auditors to report any indications of fraud or illegal acts that could significantly affect the results of their reviews of QI compliance.

We cannot say that having this reporting requirement in place would have forestalled UBS's efforts to defraud the U.S. or led to earlier detection. However, the type of fraudulent activity engaged in by UBS is what our recommendation would cover.

That concludes my statement. I'd be happy to answer questions.

SEN. BAUCUS: Thank you very much, Mr. Brostek. Mr. Josephson.

MR. JOSEPHSON: Thank you, Chairman Baucus, Senator Grassley, other senators. I'm very happy and honored to be able to appear before the committee again. As the committee knows, I've prepared a very detailed statement that actually harks back to the committee staff recommendations in June of 2004 for charity reform. Many of those recommendations have been enacted. Too many have not. I would like to submit my statement for the record. It contains the details of the proposed changes in the code affecting both publicly supported charities and private foundations that I hope the committee will seriously consider.

SEN. BAUCUS: Without objection it will be put in.

MR. JOSEPHSON: Thank you. I would like to make a few general remarks about what I think the implications for charity the Madoff scandal has and what I think the committee and the Congress needs to do to try to ensure that charities do not get so involved again.

The Madoff scandal dramatizes the need for Congress to make a public policy decision that has needed to be made for a long time but which it has deferred. We can go on as we have been, paying lip service to the federal and state laws that affect fiduciary investment responsibilities. In fact, the state laws are extremely difficult to enforce and have very little teeth, and the jeopardy investment rules which are most pertinent to the Madoff scandal have also very little teeth, and the enforcement resources available to the IRS to do something about them are meager and inadequate to the task.

These facts send to charitable fiduciaries the wrong but unmistakable message that their fiduciary responsibilities somehow are less onerous and less important than those that they owe -- for example, the trusts some of them may have for their children. Alternatively, Congress can and should rewrite not just the private foundation jeopardy investment rules, though they certainly need to be rewritten, and apply it not just to private foundations but to all exempt organizations, including public charities. But Treasury also can rewrite the jeopardy investment regulations to make them as detailed and comprehensive as the excess compensation and benefit regulations are with respect to public charities that pay too much to their managers.

And while Congress is doing this, hopefully it can clean up various anomalies in the code between the treatment of public charities and private foundations and the treatment within those categories that I discuss in detail in my statement. And most important, Congress can at least give the Internal Revenue Service the resources that it should have had since 1969 to do the necessary public charity and private foundation enforcement that 40 of the 50 states do not do at all and the other 10 do inadequately. Otherwise, the parade of charity scandals will continue endlessly.

Of course, the charities' trade associations will object. They will argue that we will not be able to get people to serve as directors or trustees, but I know of no systematic empirical evidence that that is true. From my own experience I know that if one truly cares about doing good, one serves, one takes one's service seriously, and one accepts those responsibilities and those liabilities. The charities' arguments in this area remind me of those that were made when I was the head of the Charities Bureau and Attorney General Eliot Spitzer reversed the longstanding precedent of his predecessors to give donor standing to enforce their restricted gifts.

The charities argued that there will be a plethora of lawsuits that charities will have to spend charity money defending. Well, unfortunately perhaps, that has not happened because, unlike one example, the Robertson family in the Princeton case where I was an expert witness, too few donors have the motivation, the resources, and what Mayor La Guardia used to call the intestinal fortitude to enforce their restricted gifts.

The committee staff recommended, in June of 2004, that the size of charity boards should be limited. Most of them are far too big, as compared, for example, to the for-profit boards of public companies. This is bad because the responsibility of those fiduciaries is diffused and diluted and those fiduciaries do not feel and cannot be held accountable for what they do.

Thank you, Mr. Chairman. I'd be glad to answer any questions.

SEN. BAUCUS: Thank you very much, Mr. Josephson. That was very persuasive.

I'll start with you, Commissioner. Let's just take, say -- just do the math -- say an investor who lost $500,000 with Bernie Madoff. Under these new guidelines -- maybe not so new -- what would the tax treatment be? What could the investor recoup?

MR. SCHULMAN: Well, a couple things. One, any investment made with -- and I want to clarify, the ruling and procedure we put out today is trying to be applicable to all Ponzi schemes --

SEN. BAUCUS: Right.

MR. SCHULMAN: -- not just the Madoff situation. I'll use the example under Madoff. It's an investment theft loss. If the 500,000 (dollars) -- it can include both money put in as well as earnings over time that were left in their account with Madoff.

SEN. BAUCUS: Right.

MR. SCHULMAN: And this is assuming they paid taxes on those earnings.

SEN. BAUCUS: Correct.

MR. SCHULMAN: It will be deductible in the year discovered, and we give some guidance in the revenue procedure about how to determine what the year is that it's discovered.

SEN. BAUCUS: The full 500 (thousand dollars)?

MR. SCHULMAN: Excuse me? And then --

SEN. BAUCUS: I'm sorry, what's deducted? What amount?

MR. SCHULMAN: An amount, and then we have the procedure of safe harbor that says you can deduct up to 95 percent without us, you know, looking further. I mean, we'll obviously make sure the documentation is correct, but there is a safe harbor of 95 percent immediately. Subtract from the 95 percent private insurance including SIPC that you might get back, and you can deduct that 95 percent immediately, and then the remaining 5 percent, if you recover more in later years, it's taxable if it's over -- if you've already taken a deduction. And if you don't recover the 5 percent, you can then take that deduction later. So there's basically a safe harbor for 95 percent.

SEN. BAUCUS: So about 95 percent is deductible then, basically?

MR. SCHULMAN: More or less.

SEN. BAUCUS: More or less, okay. And these regulations, when are they in effect? When can taxpayers expect to be able to utilize them?

MR. SCHULMAN: They can utilize them immediately. We plan to put them out on our website later today.

SEN. BAUCUS: Okay. With respect to offshore problems, Mr. Brostek, last week the Finance Committee released a bipartisan preliminary draft of legislation intended to give IRS more tools, about eight proposals. One is information reporting to the service when funds are transferred to offshore accounts and another requiring the Federal Banking Account Report, FBAR, to be attached to tax returns. Just give me a sense of how effectively will this help us begin to solve this problem of --

MR. BROSTEK: Well, as I noted in my statement --

SEN. BAUCUS: -- of evaded taxes.

MR. BROSTEK: As I noted in my statement, when compliance is really dependent on the self-reporting of individuals, data indicates that taxpayers tend to take advantage of that lack of transparency.

SEN. BAUCUS: Right.

MR. BROSTEK: In general, the provisions in the bill appear to be trying to get more transparency --

SEN. BAUCUS: Right.

MR. BROSTEK: -- over the transactions of individuals.

SEN. BAUCUS: Right, right.

MR. BROSTEK: And therefore, they ought to have something of a deterrent effect on the non-compliant behavior, reduce it just because the reporting is there. And the provision should also give IRS some additional information to use in making more efficient use of its own resources to identify who is likely being noncompliant, and when they're doing audits, to be more efficient about conducting those audits and determining how much noncompliance there is.

SEN. BAUCUS: But how effective do you think it will be? I mean, is this enough? Can you do more? What's your sense? If we want to close this down, this overseas tax evasion, this tax gap, what do we have to do?

MR. BROSTEK: Well, I hate to be pessimistic but I don't think that we're ever going to --

SEN. BAUCUS: I want you to be realistic, but you're a good public servant. (Laughter.)

MR. BROSTEK: To be realistic, I don't think we are ever going to completely shut down tax evasion.

Those who would like to evade tax are very inventive. They have people who are very inventive for them. Particularly those who have a lot of resources can hire very good talent. So I can't say how much precisely your proposed legislation would reduce the gap. I do think it would be helpful. I do think it would reduce the amount of noncompliance.

SEN. BAUCUS: So what more could we do?

MR. BROSTEK: I don't have a set of proposals for you today.

SEN. BAUCUS: Well, just some thoughts, some ideas.

MR. BROSTEK: Okay. Well, as I noted in the statement, I do think that one of the things you have in your legislation is to expand the period of time that IRS has to conduct audits, to extend the statute of limitations.

SEN. BAUCUS: And we do that from three to six.

MR. BROSTEK: Yes. And I think that's desirable for a number of reasons, but in part because IRS agents are very careful not to extend over the statute of limitations. When we did our review of this situation, we found a number of individuals -- I believe it was about 35 agents -- who had been disciplined for taking more than the statutory allowed time in a two-year period. So extending the statute will make the IRS agents more able and willing to investigate complex cases that run beyond a three-year period.

SEN. BAUCUS: Okay, before I do that I just -- you know, Americans are quite angry about these -- (inaudible) -- quite angry about these AIG bonuses paid and other bonuses paid. And so my basic question to you -- and it really outrages me, as it does I think most Americans -- we want to do what we can to stop this nonsense, and President Obama has made lots of statements about he's trying to stop it. I think to some -- at one point the Treasury was in a position to stop the bonuses but for some reason it did not, I think in part because they listened to the argument, we need those folks who are experts and all that and if they don't get their bonuses they might leave. They don't know how to unwind all this stuff, and I don't think -- that has no effect on me. There are enough bright people in this country who are actually going to work to try to unwind this. People there don't have to receive bonuses to stay.

As I'm told, they're really retention bonuses -- retention bonuses designed to encourage the folks from the product section to stay, but I don't think those bonuses should be paid. And I don't know if logically we can go back and get them -- don't know -- but another option is to tax them. And so the basic question is what's the highest tax that we can impose on those bonuses that is sustainable in court?

MR. SCHULMAN: Let me say a couple things, Mr. Chairman. As a citizen, I share your outrage. I can't add a lot to what the president said yesterday, that he was outraged by these bonuses. I think -- you know, we obviously operate within the contours of the tax law, and I haven't looked and don't know the specifics of this situation but I will tell you what -- you know, I heard you say earlier that this committee is going to look at this, and we stand ready, as we explore these issues for the IRS, to do what it can to assist in that exploration with both the committee and obviously with the Department of Treasury, but I can't answer that.

(Cross talk.)

SEN. BAUCUS: Right, well, you're likely to work with us, and we'll work with others too. We've got to find an answer to that question: What's the highest excise tax we can impose that's sustainable in court?

Senator Nelson, you're next.

SENATOR BILL NELSON (D-FL): Perhaps 90 percent, Mr. Chairman.

SEN. BAUCUS: Let's find out what it is.

SEN. NELSON: I want to congratulate the IRS and the Justice Department when you exposed the massive fraud on the Swiss bank UBS. Do you have any reason to believe that UBS is a one-time aberration, or are there other banks out there engaging in this fraudulent activity?

MR. SCHULMAN: Yes, thank you for your commendation. We've been trying to be very aggressive around offshore tax evasion.

I guess I can't speak to other financial institutions. I think as Mr. Brostek said, you know, this is an issue that people will push the envelope on. What I will tell you is we have a robust voluntary compliance initiative. We have a whistleblower program. We know that taxpayers who were hiding assets overseas, we have their attention and they're very nervous because the IRS is applying more pressure and committees like this are talking about legislation. I'll also tell you that financial intermediaries that are facilitating this through a lot of formal and informal conversations have paid attention and are making sure they've got their ducks in a row and are abiding by the Qualified Intermediary program. We're going to intensify and add to the tools in the Qualified Intermediary program and then hopefully work through some legislation.

And so I can't talk to you about numbers and I can't talk to you about specific investigations, but I can tell you that we are heartened by the successes we've seen in this case. We plan to continue pursuing our summons around this case, and we're going to pursue anyone we find that is facilitating offshore tax evasion.

SEN. NELSON: Okay, so the answer is you don't know of any others.

MR. SCHULMAN: I think the answer is we've got a whole bunch of things we're looking at. We have taxpayers coming in under the whistleblower program. I'm not in a position to speak publicly and authoritatively about others but I can tell you this is an area we're looking at very closely.

SEN. NELSON: All right, well, thanks to the chairman we're going to get into some legislation on this. The chairman has filed one version. I've filed another version with Senator Levin.

There is a unique little wrinkle here that an American citizen can go to a very exclusive tax shelter, the Virgin Islands Economic Development Program. How many taxpayers participate in this Virgin Islands tax shelter and what kind of oversight is the IRS exercising on them?

MR. SCHULMAN: The first question, I don't have the number. As you know, the law allows the U.S. Virgin Islands to set up its own economic development zone and have special tax rates. Anytime we see special, significantly lower tax rates it's obviously potential opportunities for people to play games. We have some public lawsuits going on around this. We have a number of open cases where we're pursuing these issues. The real issue hinges on the residency -- is someone really a resident of the U.S. Virgin Islands and what's their source of income? Is it U.S. Virgin Islands source or U.S. source? Very fact-intensive and we've got a number of open cases, some of which are docketed and you can see in the courts.

But we're pretty focused on this just like we're focused on, you know, a lot of places that have much lower tax rates where people are taking advantage of the system.

SEN. NELSON: Will you share with the committee how many taxpayers participate in this Virgin Islands shelter?

MR. SCHULMAN: Yeah, I don't know. I will share with you what we have. I'm not sure we have a clear definition of the Virgin Islands shelters but I'll get you as much information as we can.

SEN. NELSON: Okay, thanks to the good work of the GAO, you found out that a number of financial institutions that have been receiving considerable federal assistance from the TARP program have utilized the subsidiaries in countries or territories as tax havens. For example, AIG has five subsidiaries in Bermuda, Citigroup has 90 subsidiaries in the Caymans, Bank of America has 59 subsidiaries in the Caymans and even others in the Bahamas, Bermuda and the Virgin Islands.

Now, naturally part of this outrage that the chairman has talked about is that the taxpayers want to know why, if they're receiving all of these bailouts, are they also getting the shelter in these tax havens? Is it valid -- a valid business reason that they are creating these entities? So do you believe that tax avoidance underlies the decision or is it a legitimate decision by banks to create these subsidiaries in low- or no-tax jurisdictions?

MR. BROSTEK: I think it's a mixture, sir. The work that we did for the chairman and ranking member on the Cayman Islands suggested that there are subsidiaries created in some of these low-tax jurisdictions for what I think we would all agree are fairly legitimate business purposes. For instance, we saw that the sale of U.S.-manufactured aircraft was facilitated through the overseas private investment corporation, a U.S. government-affiliated entity that had worked with Boeing, other manufacturers to sell airplanes through the Cayman Islands. But I also think that a number of these facilities are set up for illegal tax avoidance, trying to minimize the tax that the corporate structure pays as a whole, and there are undoubtedly some situations where these are used to step over the line and illegally evade tax.

SEN. NELSON: Mr. Chairman, we've got to put a stop to this nonsense.

SEN. BAUCUS: It's an outrage. It's an absolute outrage.

SEN. NELSON: It's part of the way that we can solve the budgetary deficit problem: Get the tax that's owed instead of allowing all of this tax avoidance.

SEN. BAUCUS: That's true. I mean, as Mr. Brostek said, I don't think we'll -- I mean, first we have to distinguish between individual tax evasion and corporate, with respect to tax havens. There is a difference. But nevertheless, the tax gap in each case is very, very large and it's about time -- you know, this country has given lip service to that for a while. We've made several attempts at it; we've never really done enough significantly about it and now is the time to do it.

Senator Enzi, you're next.

SEN. MIKE ENZI (R-WY): Thank you, Mr. Chairman. I appreciate you holding this hearing today. It's already been educational and I appreciate Commissioner Schulman's explanation of and clarity of the announcement on the tax treatment --

SEN. BAUCUS: I noticed you were listening very intently to --

(Cross talk.)

SEN. ENZI: I'll submit a few questions that are probably more technical than anybody around here would be interested in, but I would have been interested in a little more clarity on that. But it is clear that there was massive under-sight of this fraud by both the Securities and Exchange Commission, charged with investor protection, and the Financial Industry Regulatory Authority, charged with the oversight of the broker-dealer members. Can you give me a little idea of your authority as IRS commissioner in investigating false income statements in this regard? Can you give us suggestions of ways that the IRS can keep this from happening?

MR. SCHULMAN: Well, you know, at the end of the day most of our enforcement resources are focused on making sure we collect the proper amount of tax, and that's what we've been focused on. You know, it's not our primary responsibility to oversee investment schemes.

With that said, we've got, for instance in our Criminal Investigation Division, some of the best forensic accountants who can follow the trail of money in criminal cases. We make those people available to the FBI, to other agencies who are investigating fraud and will continue to do so. I believe that information sharing amongst federal government agencies, so we all view ourselves as the U.S. government trying to do right by the American citizens, is the way we should approach things. So to the extent we can either synthesize information or we can compare information on tax returns, albeit within the responsible not sharing of taxpayer data and not breaking that trust is important things to do.

And so we actually have had conversations with a variety of our agencies about what of our resources we can offer to help them as they try to go after a whole number of frauds that have come to light around this current financial crisis that we're in.

SEN. ENZI: It's estimated that we stand to lose about 17 billion (dollars) on this tax scam in taxes that we won't be able to collect.

MR. SCHULMAN: On -- I'm sorry?

SEN. ENZI: On the Madoff scheme.

MR. SCHULMAN: I hadn't heard that estimate. I'm sorry.

(Cross talk.)

SEN. ENZI: I would be interested in an estimate of what was probably lost by the time we do the tax adjustments that will be coming up.

Chairman Baucus's proposal for treatment of offshore funds transfers requires financial institutions to report to the IRS any amount of funds transferred out of the country. Based on my reading of the text, this includes transfers such as remittances to families living abroad and U.S. citizens making purchases overseas. Could you comment on that interpretation?

MR. SCHULMAN: I can't comment on the interpretation because I think, you know, the legislation will still be hashed out. I would refer the committee to that.

(Cross talk.)

SEN. ENZI: Right.

MR. SCHULMAN: What I would say is I've had a lot of conversations with this committee, with the chairman. One of the keys to really getting after the tax gap, if not the key, is information reporting. And so, as a general concept, I'm a big fan of information reporting. This specific proposal we're going to look forward to working wit the committee on. Anytime we get information reporting there's a responsibility for us to take that information and make sure we sort through it and pursue people who are involved in abusive transactions and not pursue innocent people who are just in the business of doing financial transactions.

And so if that is in there, I think the onus will be on us to make sure we're not, you know, pursuing somebody who is wiring money to their daughter who happens to be studying abroad but that we're actually following a money trail to people who are hiding assets overseas and trying to avoid paying taxes.

SEN. ENZI: And what particular groups would those be?

MR. SCHULMAN: Excuse me?

SEN. ENZI: What particular groups would those be that this would now target that we're not already requiring reports for income transfers under the current law?

MR. SCHULMAN: Well, as I understand it, the proposal is actually putting a responsibility on the financial institution to send information to the IRS. Right now every citizen has to voluntarily report what's happening overseas with their account, the taxes that they are due. And, you know, the problem with that system is honest taxpayers are reporting and paying taxes; dishonest ones we don't often have a line of sight to, and so I think all these legislative proposals are trying to get at the line of sight so that honest taxpayers cannot be footing the bill for the dishonest taxpayers.

SEN. ENZI: Thank you, and my time is expired and I look forward to working with the chairman on that proposal.

SEN. BAUCUS: Thank you, Senator. I might say that clearly we need to work this out so that, you know, some of the concerns that you're implying are addressed, and I think the main point being this is third-party reporting -- third-party information reporting and it gets at the point that Mr. Brostek was making that sometimes people don't voluntarily report everything. The average American taxpayer I think does, but I think to a large degree we're not talking about average American taxpayers and we need third-party information reporting. Thank you.

Senator Schumer.

SEN. CHARLES SCHUMER (D-NY): Thank you, Mr. Chairman, and I want to thank you for holding this hearing at the -- in part at least of the request of Senator Cantwell and Senator Menendez and me --

SEN. BAUCUS: Right, you're welcome.

SEN. SCHUMER: -- and I appreciate that. I have a brief opening statement to make and then I'll ask some questions of the commissioner.

The perfidy of Bernie Madoff is now well known. His Ponzi scheme victimized not only well known names such as Stephen Spielberg and Fred Wilpon, the owner of the Mets, but hardworking middle-class people who thought they were making prudent investments for their retirement. Madoff's fraud has jeopardized dozens of union pension funds in upstate New York, as well as 150,000 philanthropical foundations. The fraud affected hardworking middle-class individuals who thought they were investing wisely and safely for their retirement years, and just like that they're wiped out.

I would like to ask the committee's permission to enter into the record personal stories of three Madoff victims: Ronnie Sue Ambrosino, Friedman, Adriane Biando. The pain this man inflicted is as widespread as it is piercing. Two weeks ago today I wrote you, along with Senators Menendez and Cantwell, asking for the Finance Committee to hold a hearing on the various tax issues related to the Madoff fraud. I asked for the hearing because I was worried that not only had people lost their life savings but they also would have paid taxes on money they never received and they should be able to get that money back.

I want to thank you, Mr. Chairman, for agreeing to the request and scheduling the hearing so quickly. After Madoff's arrest, several questions arose about provisions of the tax code related to the theft loss deduction, and when taxes paid in past years on phantom income might be eligible for a refund, among other issues. People were confused about what to do on their 2008 tax returns and needed guidance from the IRS. I am very pleased that the IRS has decided that in each area in which there was a major dispute that the IRS sided with the victim. The IRS ruling says that people can take a theft loss deduction in 2008 from any money directly invested with Madoff, including any reinvested gains, and that such losses can be carried back for five years and forward for 20 years.

By treating the theft losses this way, victims will not have to worry about filing amended returns for prior years. This means that victims will not owe taxes on income they never received. Victims will receive the most lenient tax treatment in a simple and straightforward way. The guidance the IRS is issuing today is clear. It's comprehensive and it comes at a crucial time, and I want to thank the commissioner and your entire team for their good work with my office and those of others. There are some issues left unresolved and I will explore those in questions, but for the most part I believe the prominent issues have been addressed and we are hearing from victims and their lawyers that they are very pleased with what the IRS has done.

So I want to thank you, Mr. Chairman, and now I'd like to just, with my remaining time, ask a question or two, first to the commissioner. And, again, thank you, Commissioner. You did a very good job here.

You testimony states that the safe harbor procedure outlined by the IRS says that taxpayers should deduct from their losses their expected SIPC recovery of 500,000 (dollars) per investor. I can see how part of this guidance might raise questions since it might be many years until the SIPC claims are paid or until it's clear that the SIPC recover will be. Does the IRS guidance allow taxpayers to simply decline to make an SIPC claim and assert the position by some form of affidavit and increase their eligible theft loss? Why wouldn't it be preferable to allow people to defer the SIPC reimbursements and take the full tax loss now, but if they receive an SIPC claim in the future, then the tax implications can be taken into account at that time because people are worried, they're desperate, and they don't know what the SIPC is going to do for them yet.

MR. SCHULMAN: Yeah, a couple of issues. One is we've actually met with SIPC -- I've met with the chairman. You know, unfortunately in this tragic situation probably the best chance of people getting some money back is through SIPC and then recovering some of the taxes that they've paid. And so it's important.

What I would say is each taxpayer is a little different. SIPC is treating, you know, some different -- they're treating people directly invested differently than they are people not directly invested. And so, you know, the way that our guidance reads -- and, again, it's not just Madoff, because we're trying to cover Ponzi schemes in general because in down economies that's where you usually see more Ponzi schemes come to life -- is that it's adoptable except for reasonable prospect of recovery.

So what I guess I would say is whether or not people expect to get SIPC is a fact from circumstances, depending on where they were situated in this Madoff scheme, and people are going to have to use their best judgment coming under the safe harbor. And, again, there is a true-up at the end, so if they get money and they took a deduction they're going to have to pay taxes on it. If they didn't -- if they thought they were going to get money and they never get it, they can take that as a deduction later.

SEN. SCHUMER: I would just ask you in this guidance to be, again, as much on the victims' side as you can be, given the awful situation they're in.

SEN. BAUCUS: Thank you. Senator Menendez.

SEN. SCHUMER: Chairman, I have other questions. Are we going to have a second round?

SEN. BAUCUS: Yes.

SEN. SCHUMER: Great. Thank you.

SEN. BAUCUS: Senator?

(Cross talk.)

SEN. ROBERT MENENDEZ (D-NJ): Thank you, Mr. Chairman. I want to join -- my other colleagues here asked you for this hearing and I appreciate you doing it so quickly as well.

SEN. BAUCUS: You bet.

SEN. MENENDEZ: Bernie Madoff is probably the most visible and incredible example of a calamitous failure of the federal government's responsibility and its regulatory agencies to oversee the market, and we've had some of those hearings in the Banking Committee. The failures of regulators to detect his crimes are pretty outstanding and we're left with the aftermath of personal tragedies for people who have had their entire life and their nest eggs become empty shells and face some real difficult choices in their lives.

So I appreciate, Commissioner, the guidance that you're issuing today. I want to follow up with one or two questions to -- hopefully you'll have the answers, and if not we'll hear it subsequently. Just to follow up on Senator Schumer's question, according to your guidance, the victims of the Madoff scandal who invested through feeder funds have to wait for those funds to file their tax returns and distribute the proceeds from the Securities Investor Protection Corporation payments and the deductions proportionately. Now, this leaves a lot of these victims, many of whom had no idea that they were even invested with Madoff, at the mercy of the contracting of their funds.

I know you said you had a meeting with the head of the SIPC. Is the IRS going to appropriately monitor the distribution of these proceeds through the feeder funds to ensure individual victims receive a timely and accurate payment from the funds?

MR. SCHULMAN: Senator, you know, we're pretty focused on this issue of direct investors, indirect investors, feeder funds.

What I would say is we didn't make up any new law in putting out this guidance. We did our best interpretation of existing law. The way that any investor in any kind of loss through a fund gets that is usually through their K-1. And so it's really going to be up to the direct investor to claim this deduction, and then flow through to their partners or you know, whoever else -- you know, however it was structured, LLC, partnership -- the losses.

And so if you invested in a partnership that then invested in Madoff, the only way you're going to know what the gains were in that partnership for other investments, what the other losses were and what the Madoff issues were, is waiting to get that partnership returned through your K-1. They should -- what we'll be doing is making sure that the loss is appropriate for the actual partnership when they file it to us.

So I'm not sure if I answered your question, but the bottom line is that that's how they'll get it.

SEN. MENENDEZ: Yeah. I'm just concerned that while they have to wait for the feeder funds to do their work and their reporting, that they're left out there waiting. So it's going to depend upon the diligence of the feeder funds at the end of the day.

MR. SHULMAN: At the end of the day, I mean, I think there's no other way. And any sort of partnership that you can file a tax return, you've got to know what the partnership has.

SEN. MENENDEZ: We'll have to look at how those feeder --

MR. SHULMAN: Yeah. We'd be happy to look at it and talk with your office.

SEN. MENENDEZ: Let me ask you: In terms of documentation of losses, what's going to be considered proper documentation to establish losses, particularly? I know that you're generally looking at ponzi schemes in general, but due to the Madoff fraud, is our -- for example, is the IRS going to permit those who were feeder group victims to establish that they incurred losses by the use of statements and other documentations that they received from the feeder group?

MR. SHULMAN: Yeah, I mean, I don't -- in general, yes. I mean, this is general guidance, but in the Madoff case we anticipate statements are good enough, because people actually -- you know, they got this phantom income. They paid taxes on it. The idea is you can now get a deduction for it.

SEN. MENENDEZ: Let me ask you. In our letter to you, we asked whether or not you're going to establish a special unit to process claims related to the Madoff fraud and similar frauds, simply because of the efficiency and size of this particular Ponzi scheme. Is that something that you're contemplating at the agency?

MR. SHULMAN: What we've done, you know, across the board we've taken a look at this very significant economic downturn that we're in. And everything from NOL carry backs for small businesses to individuals in hardship situations to those who have ponzi schemes, made sure that we've got streamlined processes to take care of it.

And so what we've done is already have units that can take care of this. You'll notice that there's going to be a special form if you're looking to operate under the safe harbor. So you'll self- identify that you're a victim of a ponzi scheme and those returns will be handled, you know, appropriately and expeditiously.

SEN. MENENDEZ: Okay.

I have other questions. I'll submit them for the record. One of them is about how we treat IRAs -- particularly certain types of IRAs -- of individuals who got invested in Madoff unknowingly, but they were invested there and how those are going to be treated.

Thank you, Mr. Chairman.

SEN. BAUCUS: Thank you, Senator.

Senator Grassley.

SEN. GRASSLEY: Mr. Chairman, if I could, before I ask questions, reinforce the dialogue that we had at the opening of this hearing.

You alluded to some ways in which we could make sure that the intent of a portion of the TARP legislation be carried out. In that legislation, the Finance Committee insisted that executive compensation be limited by ways of one, the loss of tax deduction for the institution; and two, a penalty tax for executive -- in the cases of excess golden parachutes.

Under the legislation as enacted, these tax limitations only applied in the case of an asset sale. But last year, we were told that Treasury would no longer purchase troubled assets in an auction sale. Instead, Treasury has and will continue to infuse taxpayers' funds into a financial institution largely through direct purchases.

It is now high time that we apply the tax-related limitations to direct purchases. I know that Treasury made an attempt to do this in Treasury guidance. In my opinion, that guidance falls short of enforcement. Enforcement should be stronger if the limitations were written into the code. And while we're at it, we should write other limitations into the tax code like claw-back policies and other penalty taxes on bonuses. So I wish you'd consider that at least.

SEN. BAUCUS: You bet.

SEN. GRASSLEY: Mr. Commissioner, as I mentioned in my opening statement, I appreciate that the IRS is moving quickly to assist taxpayers during these difficult times -- including victims of ponzi. However, I am concerned that the guidance issued today will cause tax cheats to consider taking abusive deductions.

SEN-FINANCE-PONZI-SCHEME

Foreign tax credits are designed so you don't pay taxes here and somewhere else, not so you can generate a tax somewhere else and get a deduction multiple places around the world.

That wouldn't have happened if we weren't co-locating people and in deeper dialogue with people.

And so I think it's going to be a combination of bilateral treaties, multilateral pressure, aggressive enforcement action, potential for policy changes, as well as real dialogue and cooperation among countries that have like interests.

SEN. STABENOW: Thank you, Mr. Chairman.

SEN. BAUCUS: Thank you, Senator.

Senator Snowe.

SEN. OLYMPIA SNOWE (R-ME): Thank you, Mr. Chairman.

And, like everyone else, I share an outrage over the payment by AIG and their announcement of bonuses. It certainly is a staggering insult to the American people.

It's in a total disregard of the reality of the magnitude of their unconscionable behavior in the first place that has wreaked havoc on the average American, upended and disrupted their lives -- people who struggle every day to make ends meet, live by the rules, work by the rules, and now they're losing their jobs or losing the value of their pensions. So I think that this is something that we clearly have to focus on.

And, in fact, in talking about the bonuses, we had the opportunity during the stimulus debate -- in fact, Senator Wyden and I had legislation that was passed by a voice vote on the Senate floor that would have retroactively given choices to companies -- and that would have applied to AIG in this circumstance -- where they either pay a 30 percent excise tax on those bonuses or they would have to return the TARP money, the money the taxpayers have given to AIG and all the other troubled institutions.

And we fought during the conference to maintain that provision. Regrettably, it was dropped, and regrettably -- we could have been in a situation today very different, had that provision become law.

And so I would hope, Mr. Chairman, we would reconsider it. I hope we could take action. Perhaps we'd change even the taxation. We used the TARP tax rate of 35 percent but it would have applied, in this instance, for AIG for any contracts, any commitments that were made during the course of 2008 for any bonuses that were paid or were about -- were going to be paid.

And so we would have been in a different situation entirely today, had that provision been enacted and accepted by the conference.

Mr. Shulman, UBS has paid 782 million (dollars) in taxes and penalties for criminal offenses. And (as we know ?) AIG disclosing it's transferred billions of dollars to financial institutions, one of which, of course, is UBS.

And we know that they have received 800 million (dollars) plus $1.7 billion, for a total of $2.5 billion. It's extraordinary to me that we would have had this kind of transfer to an institution that had secret bank accounts.

We know that they have been willing -- they have agreed with our government to disclose the 250 accounts and their identities. But at one point during the mid-2000s, they had more than 52,000 accounts.

I think it just looks like we're simply laundering this money through AIG so that UBS can pay back their $782 million that they paid for criminal offenses to the United States government.

Would you respond?

MR. SHULMAN: Yeah. Well, a few things. One is, as I said before, I can't really add much to what the president said yesterday about AIG. But as a citizen, I share your outrage about the bonus situation.

Regarding UBS, we're actually still in active litigation with them. We're pursuing, or the Justice Department is pursuing on our behalf, a John Doe summons to get all of the outstanding bank accounts.

I've been very clear that we plan to continue to pursue that and to continue following this trail. I can't really speak much more about the UBS case. The Justice Department has asked me not to, so that -- me, as the leader of an agency, doesn't jeopardize that case, except to say for the tax evasion case with UBS we plan to pursue all the means we can to --

There's been a case against the institution, and now we're making sure we go after the U.S. citizens that were using that institution to facilitate tax evasion.

SEN. SNOWE: Well, I (did see ?) -- (chuckles) -- it's inconceivable to me, though, that the Treasury Department didn't look at these cash flows. So on one hand, UBS is paying $782 million in criminal offenses and penalties to the United States government, and on the other hand they have benefited through the TARP fund $2.5 billion as a result of the disclosures that were made by AIG.

So, yeah. I think that's something that should have been regarded at the outset. I don't know how it even happened in the first place. It doesn't make sense.

MR. SHULMAN: Yeah.

SEN. SNOWE: And frankly, it's preposterous. And so I don't blame the American people about the extent of their anger. And -- but this is something that, frankly, that the Treasury Department should have considered in the first place, rather than allowing this to happen.

Thank you, Mr. Chairman.

SEN. BAUCUS: Thank you, Senator.

Senator Kerry.

SEN. JOHN KERRY (D-MA): Thank you, Mr. Chairman. Thanks a lot for doing this hearing and, again, bringing this subject up as you did earlier last year. We appreciate it enormously.

This is a subject that I've been interested in and following since the 1980s when I stumbled across these issues with the BCCI case.

And I've brought a number of pieces of legislation which were passed, which have helped to increase the level of scrutiny that we have with respect to transfers. The $10,000 piece, the -- amendments with a number of countries on their cooperative efforts with us.

But clearly, clearly, we've only scratched the surface, and I want to talk about that for a minute.

The UBS effort where we know that there was a sort of initiative taken to reach out to some 20,000 wealthy Americans and actually flout the tax laws through the offshore banking services and evade over $300 million in taxes, you've mentioned the case is ongoing.

But help us, from a legislative point of view and an oversight point of view. Last July when we had the hearing, Jack Blum testified here -- and you were here, Mr. Shulman; you were here, Mr. (Brostek ?).

The problem of offshore tax evasion is exacerbated by the so- called revenue rule, the understanding that basically no government will help enforce the tax laws of another government

Do you in fact find that to be true?

MR. SHULMAN: I find it to be varying among governments. I don't necessarily find that to be true, because I think there's a lot of like-minded governments who understand that if one of our citizens is evading taxes and they don't help us, when one of theirs is evading taxes -- they need to help us.

We have treaties around that help us with information exchange.

SEN. KERRY: Let me just say, as chair of the Foreign Relations Committee, I will say that we are going to look at those treaties, and we're going to start examining the degree to which they have been enforced, not enforced, or are impediments, in some cases.

MR. SHULMAN: I think that's a worthwhile effort because what I was going to say is the model U.S. treaty for taxes has 30 provisions, everything from pensions to annuities to exchange of art -- those kinds of things -- around tax treatment. It only has one enforcement provision, Article 26. That enforcement provision is generally designed -- you need to know the name of the taxpayer, you know. Put Senator Kerry, you got a name -- you've got to name the account and go after them.

And so while treaties are useful they don't necessarily spontaneously produce the kind of information that -- that we'd like to get. That's why we use a variety of other tools like the John Doe (summon ?), like other international cooperation, like the QI program where we have other levers, and clearly the kind of legislation that this committee is considering are levers that we could use.

SEN. KERRY: Well, it seems to me that we -- we even have to go beyond that. I mean, I have found that a lot of these governments have just fundamental indifference. I remember going to visit with the governor of the Bank of England with respect to offshore entities. This was about 10 years ago. And I found a remarkable level of disinterest and even hostility towards the idea of, you know, getting involved. Gordon Brown came here, now as prime minister, a couple weeks ago and announced from the podium of the House that was have to end offshore accounts that are basically havens.

How do we do that? What's the cooperative effort necessary for you to be able to guarantee that those accounts the chairman referred to in the Cayman Islands are in fact legitimate business interests with a -- with a -- rather than just pass-throughs and cutouts and, you know, shell corporations and so forth? Is there an international standard -- this was at the G-20 even that ought to be discussed in a week or so -- that they ought to be talking about international legitimate business standards, sham transaction standard and level of scrutiny.

MR. SHULMAN: I guess I'd say a couple of things. One is I'd say there's no silver bullet. There's going to be multiple pieces of the strategy that include enforcement, regulations, legislation, as well as international cooperation. Two, is I would separate individuals hiding income offshore through sham trusts and accounts and corporations because you have two different sets of issues. I think you're asking the question about the corporation set of issues, and as Mr. Brostek said, there's some corporations just doing some business transactions that make sense internationally, there's some that are doing aggressive but legal tax planning and that gets to tax policy, and then there's some who are clearly, you know, being abusive and avoiding taxes and those are the ones that we go after.

I think one of the issues that's on the table that the president's put on the table in his 2010 budget is the issue around deferral because I think your conversation with -- in the U.K., you know, countries compete on tax rates. Countries compete to have businesses and less regulation, more regulation. I think what we've seen in recent days is that all countries are -- are connected and that there need to be some standards globally.

But, you know, probably the simplest thing is -- and it's being discussed as the president signaled in his blueprint -- is some of the deferral issues because once A U.S. corporation has to pay taxes everywhere my job as IRS commissioner becomes much easier because there's not as much incentive to play games.

SEN. BAUCUS: Senator Cantwell. Excuse me. Senator Carper. I'm sorry. Senator Carper's next. Sorry.

SEN. THOMAS CARPER (D-DE): Thanks very much. Mr. Shulman, you were good to come by my office and meet with me almost a year ago. I think it was before you'd been confirmed. You've been in your post for I think about a year now and -- is that correct?

MR. SHULMAN: A dog year. Feels like seven. (Laughter.) Well, yes. Yes.

SEN. CARPER: Welcome to the pound. (Laughter.) I -- you serve a term of five years as I recall. Is that correct?

MR. SHULMAN: That's correct.

SEN. CARPER: Any idea how long that's been the case?

MR. SHULMAN: A five-year term for the commissioner? It was part of the IRS restructuring and reformat. Ninety-eight was the first five-year term and so there -- I'll be the third commissioner who was confirmed for approximately five years.

SEN. CARPER: I hesitate in asking this question but you -- but do you think it's a good idea?

MR. SHULMAN: What's that?

SEN. CARPER: Do I (sic) think it's a good idea to have a five- year term that stretches across different terms of the president?

MR. SHULMAN: You know, my belief is that, you know, the IRS needs to be a nonpartisan by-the-book agency that enforces the law, that is removed from politics. It's also a large organization with very complex people and technology issues that take many years to actually get a strategy and -- and stick with it so --

SEN. CARPER: Well, the reason why I ask -- the reason why I ask I chair a subcommittee that has jurisdiction over among other things the Census Bureau, and we're wrestling with whether or not the director of the Bureau of Census should also serve a -- an extended term as -- as you do and other commissioners will in the future. So thank you very much. Because the -- the problems that -- that you just described with your agency are very similar to those at -- that exist in the Census Bureau. So thank you.

MR. SHULMAN: I won't comment on the Census Bureau.

SEN. CARPER: Just fill out your Census form and we'll be fine. As you may recall, when you visited with us, we talked a bit about the tax gap. You talked about how -- how information is reported. We actually do a pretty good job of collecting taxes from -- from those people. In the stimulus package that we passed we -- we sent money in a lot of different directions. A lot of it put people to work. As far as I know, none of that money was directed to the Internal Revenue Service. I'm wondering though with respect to the omnibus appropriations bill, which was just enacted and I think just signed by the president, were -- were there any resources provided in that legislation for the balance of this fiscal year that can help you and your colleagues at the IRS do your job better?

MR. SHULMAN: You know, the answer is yes. Chairman Baucus, a number of other members of Congress, have been incredibly supportive of the IRS and the IRS budget to go after the tax gap. As we talked about with the tax gap, you know, we have a proven return on investments as an agency 5 to 1, for specific programs, 13 to 1, 14 to 1, and so increasing our resources is going to be key. There were increase in enforcement resources in the current omnibus bill.

President Obama's budget outline outlines a couple of things. One is a robust IRS enforcement program but also very clearly a long- term commitment because one of the things about federal agencies is if you give a bunch of money one year and then don't in the last it takes a while to plan, to recruit. When we bring on an agent we have to pull other agents off of cases to train them. We have to put them on simpler cases and pull different inventory off.

And so that's a piece of it. The other that's quite helpful that is in the 2010 budget and this committee took leadership on was credit card reporting and basis reporting -- that the real way to leapfrog and get a real grip on the tax gap is our resources and also clearly information reporting because the more information we get from third parties the better we're going to do at our job.

And, you know, the last thing I'd say is there was $51 million in the appropriations or in -- in the omnibus bill that just passed for research for the IRS. The only real credible way to do tax gap research is to do audits of returns you wouldn't otherwise do an audit for because you don't know what's there unless you go and look in places you wouldn't look. Usually we're auditing returns that have higher yields where we see indicators that there'll be collection. We actually do random audits. And so this investment in research so we can continue to hone in and target our resources better is key, and so we -- I think we've gotten a lot of support and we're going to keep at it.

SEN. CARPER: I share the passion of our chairman and that of a number of people on our committee to go after as much of this tax money that's owed and not being collected, and we want to make sure you have the resources and personnel and technology to -- to do that -- to do that work. Mr. Brostek you've been, I think, good enough to participate as I recall maybe in a round table that we had on -- on the subject earlier, you know, several months ago. And just staying with the -- the tax gap, are there some points that you'd like to share with us that you would have us focus on this year within -- particularly within this committee to go after not just the low- hanging fruit but the fruit that's a little higher on the tree?

MR. BROSTEK: Well, there are a number of things that could be done. Looking for additional information reporting is clearly one of the best strategies. But one --

SEN. CARPER: I'm told that when the information is reported we collect about 90 percent of the -- IRS collects about 90 percent.

MR. BROSTEK: Or more, yes. I think it's up to 96 percent --

SEN. CARPER: Pretty good.

MR. BROSTEK: -- with complete information reporting. IRS knows exactly the same income items that the taxpayer knows. One area that I think is maybe a little underappreciated is the role of the paid preparer community. Well over half of taxpayers use a paid preparer to prepare their returns. There's a pretty good body of evidence that the performance of that community is not stellar.

Sometimes that may be because the taxpayer is not providing good information but there's also a -- sort of an emerging body of evidence that the preparers themselves are not always diligent and competent. I think that's one of the areas that might be worth paying some attention to.

SEN. BAUCUS: Thank you very much.

SEN. CARPER: Thank you very much.

SEN. BAUCUS: Thank you, Senator. Senator Cantwell?

SEN. CANTWELL: Thank you, Mr. Chairman, and I want to add my thanks for you holding this important hearing.

Madoff frauds and schemes defrauded about 8,000 people and over $50 billion. So on top of everything else we've been through, to have this incident happen is just unbelievable. And part of, I think, the importance of the hearing today is to also look at the regulatory reforms that we need to put in place.

But first I want to thank Commissioner Shulman for being here and to the IRS statement of guidance that was issued today. I'm very pleased that the IRS rules and procedures that we're putting in place that direct investors can have more predictability on how to handle these theft losses. And so I very much appreciate the fact that the IRS has moved forward on that.

My question is in regards to the regulatory side of this equation. Stephen Harbeck from the SIPC told House Financial Services in January, quote, "It became apparent very early in the Madoff case that the customer statements Mr. Madoff had been sending to investors bore little or no relation to reality. The records sent to customers were inaccurate when compared with the inventory of securities actually held by the brokerage firms." And so mometimes PACs regulators themselves can help be the canary in the coal mine in showing signs of danger because they can get access to information that others can't get access to. So while Madoff was sending bogus statements to his clients, they were also making real payments to the IRS.

So my question is, could the IRS have connected some of these dots sooner and perhaps focused some of the attention on the right areas? And how much interaction does the IRS, Treasury and SEC have when it comes to coordinating these very complex investment firms?

MR. SHULMAN: Yeah, you know, a couple of issues. One is the majority of our enforcement resources are focused on collecting taxes. And as you said, you know, one of the issues and the reason we're putting out guidance, people actually were paying taxes on these. And that's -- you know, frankly, we've got a big enough job to do and the complexity of the code's going up that we need all the resources we can to make sure we collect the proper amount of tax and that's where we're very focused.

Our first line of sight isn't to look at, you know, investment schemes and those kinds of things. With that said, I'm a big believer that, you know, I'm a public servant, I'm here to serve the American people, and that I need to coordinate with other leaders in the government to try to make sure that it works as efficiently as possible. We've made our forensic investigators -- especially our criminal investigators who are very good at following the money trail -- available to other federal agencies to coordinate on enforcement and fraud cases. We have a long tradition of that but we're doing that especially in some Ponzi related schemes. You might have seen we filed some tax issues around another prominent Ponzi scheme.

SEN. CANTWELL: Do you think if you would've had the resources and we had better coordination that we could've connected some of the dots?

MR. SHULMAN: You know, I think it's always easy to look in the rear-view mirror; a lot of people were duped by Bernie Madoff, from federal regulators to very sophisticated investors. We're going to continue to coordinate and assist where we can and we're certainly going to try to make our resources available.

I've actually had conversations with the chairman of the SEC about how we take tips in and I know she's moving aggressively on getting better at synthesizing tips and so I'm a believer that we can all learn from each other and that we should share as much information, expertise, personnel as we can.

SEN. CANTWELL: Do you think there's any legal obstacles for more coordination? Because, again, it seems to me that you have access to records and information that help piece the puzzle together.

MR. SHULMAN: Yes, well Section 6103, which is a pretty locked- down provision around us not sharing taxpayer information is quite important to the integrity of the whole tax system; that people feel like they're filing taxes, they're bringing it in and it's not going to be shared. With that said, that's sharing it with the public; there are some impediments sometimes to sharing with other agencies and we're certainly open to exploring if the information we have can be helpful in fraud cases of how to get those into the hands of other authorities.

SEN. CANTWELL: Well I certainly want to explore that with you but I think the inter-agency coordination and cooperation is critical on many fronts -- and I would assume the DOJ investigations, you probably do that now to some degree -- but if you did it across several agencies, that it would also help in identifying these sooner. And --

MR. SHULMAN: And I will tell you, I mean, to the other topic we're talking about with offshore -- we're actually now very aggressively having conversations with other agencies around how do we triage all the information that the federal government has to do a better job? So I very much agree with the direction you're headed.

SEN. CANTWELL: Thank you. And, Mr. Chairman, I know that this is -- you know, we've had all of this economic crisis on individuals and the impact but the amount of capital losses that taxpayers can write off against their income is limited to $3,000. And I know my colleague, Senator Bunning, has brought this up before, but I think it's something really the committee should look at and maybe spend a little more time looking at this particular area and how we can help consumers.

SEN. BAUCUS: Yeah. Thank you, Senator. I would just like to ask a few questions, Commissioner Shulman, about UBS. As I understand it, at the urgence of the Justice Department, the Justice Department wanted an agreement with UBS in which UBS agreed to turn over the names of about 250 customers suspected of evading -- of tax evasion. We're not talking about avoidance here, we're talking about evasion. And UBS also agreed to pay a fine of 80 million (dollars).

But Bobby Birkenfeld, a former UBS employee, said the U.S. persons have hidden more than 15 billion (dollars) in assets with the assistance of UBS Private Wealth Management Group. And I think the IRS alleges that approximately 52,000 U.S. persons use UBS to hide assets in that Swiss bank alone -- with UBS.

What's going on here? They've only given us names of 250; you think there are 52,000 more. What's happening here? How do we get the information we want?

MR. SHULMAN: Let me say a couple of things, Mr. Chairman. First of all, I would love to go into this case with you and brag about it because I think the IRS actually found this, brought this to light. It created international attention and --

SEN. BAUCUS: And I compliment you for that.

MR. SHULMAN: -- and, as you know, I can't really talk about specific taxpayer cases, et cetera. What I will tell you is there's two things that happened, there was the deferred prosecution agreement that was around UBS being indicted criminally -- that the Justice Department deferred that with a set of conditions that are all part of the public record. There's also the IRS's John Doe summons to force UBS to produce all of the accounts, and that's being litigated through the courts now.

And so what's going on is prosecution was deferred on the criminal matter but we're pursuing the civil matter and continuing to try to get as many of the accounts as we can. My view is we should get all the accounts, but I can't pre-judge. There's going to be a hearing in July with the judge.

SEN. BAUCUS: Right. But how do we get at the Swiss problem? Because I understand that Switzerland makes its own decision whether or not the requested name, John Doe, is violating the law. They're making their own determination themselves and if they determine, well, gee, maybe this person John Doe has not violated the law, we're not going to send the name to the IRS. That's a problem. That's not their judgment as to whether, you know, U.S. law is being violated, that's the judgment of the United States it would seem to me.

MR. SHULMAN: Yeah. One of the problems -- and we talked about treaties a little bit before -- sovereign law often trumps treaties. These indications we've gotten from some of the bank secrecy jurisdictions, including Switzerland, to comply with the OECD standards would actually have our information exchange potentially trump sovereign law. So that's one of the ways to get at it.

Bank secrecy is a big issue for us in the IRS. In the Swiss cases I understand it. For us, you send in a tax return, you sign your tax return. If you basically lied on the tax return it's tax evasion. The Swiss interpretation isn't the same. You actually have to actively -- it's not just about signing a tax return and sending it in. You have to actively conceal assets, set up phony trusts and have acts of commission rather than omission.

SEN. BAUCUS: Right. So to what degree does information reporting actually trump sovereign Swiss law?

MR. SHULMAN: Would information?

SEN. BAUCUS: What information? If we require -- this is legislation we're contemplating here -- were to be enacted, to what degree would that help?

MR. SHULMAN: Well, I think what it would do is -- I'm not sure it trumps Swiss law but we'd actually see the flows going out of the U.S. and be able to connect that to U.S. citizens. And what we're doing with the John Doe summons is trying to get the names of the U.S. citizens. So what it would actually do is potentially give us a line of sight while the money left, not years later when we're trying to grab back the money that's already gone. So I think this kind of information reporting is definitely worth exploring and could give us -- could be a great tool for us.

SEN. BAUCUS: So how many other havens are there? You know, Lichtenstein is stepping forward as I understand it; Andorra has -- Monaco has not as I understand it.

MR. SHULMAN: I read in the papers that they say they are but that's all I know.

SEN. BAUCUS: Okay. Well I hear the current position in Monaco is to make no comment at all to the state officials. Now I know what no comment means, that's just what he said. Then there's Singapore; we've got a problem with Singapore. What are some of the countries we've got problems with here?

MR. SHULMAN: Well I guess I'd rather --

SEN. BAUCUS: I know you'd rather not name.

MR. SHULMAN: (Laughs.) Yeah, listing the names of countries is the purview of Treasury, State Department. Obviously, we've got our eyes on it. I mean, I guess what I would say is --

SEN. BAUCUS: If we name names, that puts the, you know, sunshine on those countries but they will glare on them; it embarrasses them and that might do something.

MR. SHULMAN: Well I think we've --

SEN. BAUCUS: Let me just cozy in here -- you know, I'm not going to corrupt -- (laughter)

MR. SHULMAN: Let's just say I'm probably not going to be doing a lot of ski vacations in the Swiss Alps. (Laughter.) So it -- I think bank secrecy is an issue to places that have bank secrecy laws. Places that don't have information exchange agreements with us are a problem and then, by definition, places that hold themselves out as low or no tax jurisdictions. And so I'm more focused on a set of criteria. The ones you listed are all ones that are on our radar that when we see transactions going on there we go over there.

SEN. BAUCUS: Well, my time has expired. I'd just urge you to just go for it. And you have such support in this country for you to -- very, very vigorous -- very vigorous, almost embarrassingly vigorous. (Scattered laughter.) I think the American taxpayers would be very proud and I know I will personally if you do. Okay, Senator Schumer is next.

SEN. SCHUMER: Thank you, Mr. Chairman. I really appreciate your having the hearing. I think it's on two very important subjects and I appreciate the second round and all the witnesses.

I'm going to return to the issue that I care about -- well, I care about both but I'm questioning about because I agree, it's -- what did you say, Mr. Chairman? It's embarrassingly --

SEN. BAUCUS: Oh, I'd like him to be embarrassingly vigorous.

SEN. SCHUMER: Embarrassingly vigorous on offshore stuff and I agree. Okay --

SEN. BAUCUS: Right. But better -- we can back off a little bit -- just be very vigorous. (Laughter.)

SEN. SCHUMER: For this year.

SEN. BAUCUS: For this year, right.

SEN. SCHUMER: The man from Montana has spoken.

Next question -- this is back on helping the victims of Madoff. And this one's -- it sounds innocuous but it's very important technically to a lot of people -- how will the IRS handle theft losses for individual taxpayers that invested with Madoff directly but did so inside a retirement vehicle like an IRA or a Roth IRA? This is sort of uncharted waters but a lot of victims were affected inside these accounts -- average middle class people.

MR. SHULMAN: Yeah. You know, 401Ks, IRAs, retirement vehicles. If an investment was deductible going in, you can't take a loss going out because there weren't taxes paid on it. There are some exceptions, as you mentioned, like a Roth IRA. The rules get very complicated but if it's after-tax money there may be the ability to take losses but mostly you take losses at the time of distribution. And so I'd just encourage people to look at the guidance and to have conversations with our counsel's office.

SEN. SCHUMER: Right. Again, I would just urge you to be as helpful as you can to the victims in this regard -- particularly with the Roth IRA situation.

MR. SHULMAN: Can I just make one clarifying comment about your earlier comment, Senator?

SEN. SCHUMER: Yeah.

MR. SHULMAN: You talked about a five-year carry-back and indefinite carry-forward of the loss. Under general rules it's a three-year carry-back because you have an investment theft loss; it's defined as a business loss under the code and you can carry it back for three years.

A unique twist of the American Recovery and Reinvestment Act says for 2008 if you have gross receipts of less than $15 million you get a five-year carry-back. So I didn't want people listening to this to be confused. So they're going to need to look at their circumstances, look when they discover it, and --

SEN. SCHUMER: But if you were below 15 million (dollars) you're okay with the five years.

MR. SHULMAN: In 2008 yeah.

SEN. SCHUMER: Okay, good. The one point about the IRA, just to make it, the money in the IRA was still stolen in an IRA but it's still gone -- so anything you can do to be helpful, okay? Third, does the guidance say anything about potential claw-back payments that the victims who had previously withdrawn funds may have had to make? What's the tax treatment of such claw-backs under current law? Would taxpayers receive a deduction for such payments?

MR. SHULMAN: So the ruling tries to clarify existing law, not make up law, and it's deductible in the year discovered except for reasonable prospects of a recovery. And I think people need to determine that in all Ponzi schemes -- the Madoff people will understand the situation better than I will because they're in contact with the trustee of how much there is a reasonable prospect of recovery. What I will tell you, though, is there's a true-up at the end. So if people take a deduction and get that loss they're going to be able if they then get some sort of payment -- they'll just be taxed on it. If they don't take the deduction because they think they're going to get it and they never get any sort of recovery, then they can take that loss later.

SEN. SCHUMER: Good. Again, I have to repeat that the IRS has done all of the rulings and the guidance that you've given are really helpful to the victims. And I don't know if I've mentioned this. We've heard from victims themselves already since yesterday because we shared what you had shared with us ahead of time. We've heard from some of their lawyers that they're really happy with what the IRS is trying to do here. It's a rare day when someone can be very happy with the IRS and this is it --

MR. SHULMAN: It's a good day.

SEN. SCHUMER: -- in a difficult situation, so thank you. I'm going to yield back my time because the chairman has been generous. I have a few more questions. Could I ask unanimous consent to submit them --

SEN. BAUCUS: Absolutely. Without objection.

SEN. SCHUMER: -- znd the commissioner answer them in writing within say five days -- would that be all right?

SEN. BAUCUS: We could do that.

MR. SHULMAN: Yeah. But we'll get them as quickly as we can.

SEN. BAUCUS: I think we'll get them back --

SEN. SCHUMER: Thank you.

SEN. BAUCUS: -- in fewer than five days. The rule here is, what, about two or three?

SEN. SCHUMER: What is the rule?

SEN. BAUCUS: We'll rule three days.

SEN. SCHUMER: The chairman has ruled.

MR. SHULMAN: We certainly will obey the rules.

SEN. BAUCUS: We just ruled. It's three days. Okay, Senator Snowe?

SEN. SNOWE: Thank you again -- Commissioner Shulman, to follow up again on UBS, because I think it's extremely disturbing about this, frankly, and I realize it's a matter of the justice department and the IRS at this point regarding UBS and its unwillingness to disclose all of these accounts. But, regardless, we have a situation where we have given a bank $2.5 billion in federal taxpayer's money and they are paying $782 million in criminal penalties and taxes to the Unites States government for tax evasion. So the bottom line is we're giving money to an institution that has been involved in tax evasion. There's nobody in America that can understand that.

So we'd better make it abundantly clear to the Swiss government that even so -- whether we have a treaty or not -- we should make it abundantly clear. We frankly should rescind that money. I just think it's absolutely preposterous that we're in this situation today.

We're giving on one hand with the bonuses and now in the other hand we're dealing with the situation that we're giving money to an institution that has been engaged in tax evasion. I know that Secretary Geithner will be making this a priority at the G20 meeting in April -- absolutely so in terms of bank secrecy laws and tax evasion but nevertheless in this situation we need to address it. I don't think it's something that we can defer and, well, we'll go forward in the future. We're dealing with a bank that refuses to disclose all of its accounts. They're saying it's a matter for diplomatic channels between the United States government and the Swiss government -- but it's also a matter for the United States Congress and I don't think it's something that we can ever justify or accept.

So I know that going forward we'd say, well, we'll address it. We need to address this now and retroactively in my estimation because I just don't think it's at all tolerable under these circumstances. To that point, this has been something that UBS has been engaged in for the better part of the decade since 2000. Was there at any point do you know to your knowledge if anybody ever approached the IRS, similar to a Harry Markopolos, who approached the SEC regarding Bernie Madoff?

Was there anybody who ever approached IRS about UBS and these secret bank accounts at any point between 2000 and 2007 before the IRS identified this problem?

MR. SHULMAN: Not to my knowledge.

SEN. SNOWE: It's hard to imagine, actually, because this -- obviously, this institution not only failed to pay $220 million in taxes, obviously paying penalties and interest, that's $782 million.

So at no point during that decade did anybody ever approach the IRS with any indication that there was anything wrong?

MR. SHULMAN: Well, I will tell you, it's in the public record and I can only talk about the public record, but we actually, you know, through informants -- through going after aggressively other cases got onto this issue.

And so again, I mean, this is something that I think that the agency has, you know, with our stepped up focus on international tax evasion -- it got laser-like and then started pursuing the John Doe, summons, started to bring international pressure. And so you know, this is one where there's plenty of things that we don't do perfectly. We're always looking to improve. This is one where we got on top of it and are continuing to pursue it, as I said.

And I want to tell you that, you know, you've got my personal commitment to continue to pursue these matters.

SEN. SNOWE: I appreciate that too. And I appreciate the work.

Mr. Josephson, on the Pension and Benefit Guarantee Corporation that's responsible for pension plans if a company becomes insolvent, there was a case of the East River Management Company, which is no longer in operation, when -- (inaudible) -- PBGC had to take it over in December.

You know, is it routine for the PBGC to assume fiduciary responsibility for a company that didn't even diversify? I mean, should there be any standards with respect to that? Because it's clear in this case they turned over all their money to Bernie Madoff. I mean, there was no diversification within this plan. Now, PBGC is obviously having to assume responsibility for this now defunct plan.

MR. JOSEPHSON: It depends where you think, Senator, the risk of loss should fall. Obviously, diversification is required by the applicable state law. And for the failure to diversify, there could be state penalties against the corporation that did not diversify. But where is the Pension Benefit Corporation going to be able to collect that?

There is a conundrum here and I don't know that there is under state law or federal law any effective remedy in that situation. But particularly in response to the dialogue between Senator Carper and Mr. Brostek and Ms. Cantwell's question, I think we also need to focus on whether or not the accounting profession in auditing exempt organizations -- publicly supported charities, private foundations, pension plans -- is actually doing its job.

In my five years as head of the Charities Bureau in New York, I found that the resources that accounting firms -- even the big four accounting firms -- devoted to this kind of work were meager compared to what they purport to devote to the major publicly held companies.

But in that case, Senator, you will certainly remember that the failures of the auditing function for publicly held companies in effect required the federal government to federalize those accounting standards in the public company's accounting oversight board.

And there is another analogy here that I think is relevant, because of Mr. Bostrek's remark about the incident of tax evasion in returns prepared by paid preparers. There are, in fact, no federal standards for auditors that account for exempt organizations. And that is an aspect that the committee ought to take into account.

For example, there is a recent precedent. The Treasury, in response to the committee's initiative with respect to donated property, has issued regulations that really require appraisers of donated property to meet set qualifications and to express their opinions in a set form. No such requirement exists with respect to the paid preparers that prepare returns for exempt organizations.

And as I said before, my experience in the Charities Bureau is they do not devote the same kind of resource and the same kind of acumen. There is no evidence, for example, that any of the accountants that audited any of the Madoff funds ever did a walk through to try to determine whether or not the statements he was providing were actually backed by transaction slips.

Madoff's trustee, Mr. Pickard, has said publicly that there are no transaction slips for Madoff transactions over the whole 13 years of the scandal. I cannot understand why the auditing function did not at some point uncover that. And this is an important subject, it seems to me, for IRS and committee oversight.

SEN. SNOWE: You're absolutely correct and we thank you very much for those very constructive suggestions.

Thank you.

SEN. CARPER: Gentlemen, I have just a couple of questions to wrap up -- at least for me.

Again, thank you very much for being here today and for your responses and for your service too.

When I was governor of Delaware, we had -- every year we had an award that was sort of like a state version of a national award. It was offered to either businesses as quality of work for best quality for the business operation. It could be nonprofit. It could be, actually, a public candidate that won. I think my last year as governor, the winner with the Delaware Division of Revenue, because they did a very good job of collecting the taxes that were owed. They also did a pretty good job of providing customer service. And I think you've demonstrated again here today that we can do both. And we applaud you and the folks who are part of your team.

You mentioned -- Mr. Shulman, I believe you mentioned in that the IRS Appropriations Bill to fund the IRS for the balance of this fiscal year there was maybe $50 million that was appropriate, I think you said, that could be used for research and you welcomed that.

I think the last time we actually had an extensive study of the tax gap may have been in tax year 2001. And I would ask you if the IRS might have any plans to use some portion of that $50 million to update the tax gap? Are you aware of any other initiatives under way to do so?

MR. SHULMAN: Yeah. You know, the tax gap numbers, as I've gotten under it, is very difficult to estimate the tax gap. The current numbers that are public are 2001 numbers. Very few of those are actual 2001 numbers. A lot of them are extrapolated numbers of 1986 when we used to do very extensive kind of random audits to really get under it.

We've got a commitment to update the tax gap more regularly, focus on some areas where research hadn't been done, and also to do things like I mentioned before -- do some random audits, rather than just targeting the areas where we normally, you know, we try to do audits and have low or no change rate so we target it correctly.

So the answer is yes. It's all focused at what we call our national research program, which gets under reasons for noncompliance, where there's noncompliance and eventually it leads us to data-driven resource allocation decisions about how to go after noncompliance, which as you said, is a combination of good service for people who are confused by a very complicated tax code and aggressive enforcement for those who are trying to evade the law.

SEN. CARPER: Thank you.

A question for Mr. Brostek, and also for you, Commissioner.

Sticking with the tax gap, again, we all know we need additional third-party reporting areas that go beyond the measures that are already enacted. We talked about some of those today -- bases reporting is one. We talked, I think, today about credit card reporting.

I also believe that it's important to make sure that we're targeting what I would describe as the right people.

With respect to the statutory authority, the IRS has already been given -- and may be given in the future -- how does the IRS, if you will, thread the needle between increasing enforcement targeted on unscrupulous taxpayers, while not accidentally imposing undue hardships on taxpayers who are trying to comply with the law?

MR. BROSTEK: Maybe I'll start and pass it over.

The research that the Commissioner's referred to is fundamental to their being able to determine which taxpayers are most likely to be noncompliant. GAO has long supported the type of research that IRS is undertaking. It improves their selection process to ensure that they are bothering the fewest number of taxpayers who are completely compliant.

In addition to that, the IRS personnel do have informants and receive tips. They receive tips through the enhanced whistleblower protections that this committee was responsible for. All those things help IRS in identifying the most likely noncompliant taxpayers.

If I could, I'd like to mention one other thing in relation to the research that I think is sometimes under appreciated. And that's that it helps in constructing systemic solutions. The basis reporting provisions that is being implemented now -- that IRS has regulations out and they're being commented on -- grew out of research that we did using the NRP database from the 2001 tax year.

We were able to go into the files from the research to develop the case that basis reporting was practical and would have an effect on the tax gap related to that particular problem. So it's not just that that research helps with the selection of routine audits, it helps us revise regulations and create statutory solutions to the problem.

SEN. CARPER: Thank you. And Mr. Commissioner, if you'd just respond briefly, please.

MR. SHULMAN: Yeah. I mean, I think that -- I guess I don't think it's necessarily a choice, the way I'd think about it.

Basis reporting, for example. Everyone who's compliant has nothing to fear. There's a lot of compliant taxpayers. They spend a lot of time, when they sell a stock, digging around and trying to figure out what was their basis when they bought it and if they reinvested dividend.

And so I think a lot of people who are trying to be compliant are actually going to welcome third-party sends it to us, third-party sends it to you, you attach it and you're done versus the rigmarole you go through now trying to figure out what your basis was.

And so if done right, information reporting -- rather than us suspecting you and going and doing an extensive audit, which is more burdensome -- actually, if done right, is less burdensome, gives us the information, allows us to do our compliance job without a full- blown audit and so should be quite helpful.

Like I said before, you know, our job is, as we get information, to make sure that we use it appropriately and only with people who aren't -- or as much as possible with people who aren't compliant.

The other thing I would just say is there's something about information reporting that has a direct enforcement effect. It also -- people's behavior changes when they think you can see. So the W2 -- people are very compliant, not because we're running so many W2 versus income checks. We do it automatically, so we see all your W2s. But also it's just -- no one, I think, would think about lying about their wages, because they know its sent right to the IRS. And so it has an inadvertent -- you know, it has a real affect on voluntary compliance as well as on our direct compliance program.

SEN. CARPER: That's a very good point.

Again, thank you for your testimony today. And Mr. Chairman, I've got another question or two I'd like to submit for the record. But you've been very helpful. We appreciate your participating and your testimony.

SEN. BAUCUS: Thank you, Senator.

Mr. Commissioner, I just have a question about your budget. You're getting a slug of -- you're getting a big increase in your budget, which is great. I think instead of 11 billion (dollars) is that correct, you've got 13 billion (dollars) if the president's proposal's agreed to?

MR. SHULMAN: It's a significant increase. I don't think -- the details haven't come out.

SEN. BAUCUS: Okay. I understand it's very significant.

The question is: How do you intend to put this extra funding to work? What are you going to do with it? And what about offshore enforcement and what component is offshore enforcement? And third question is what goals, what milestones, what measures, what benchmarks do you put in place to determine whether or not you're successful?

MR. SHULMAN: I'm happy to go through that with you.

We're going to put the budget to work by making sure we get the right personnel to do what we need to do is one component. We're going to hire examiners, agents -- special agents who, some of which, we'll put offshore in other localities. We're going to hire economists, financial products specialists, appraisers, lawyers -- all the people we need to go after the complex trail of money that is involved both in the U.S. and overseas.

We're also going to use it to perfect the data we have in house so that we're doing data modeling correctly -- innovate around data modeling so that we're going after the right evasion that happens both here at home and overseas. Get third-party information in and combine it with our data, so we can again be better at target and using data from other agencies and other countries to make sure we're triangulating in on enforcement issues.

We're also, just in a growth sense, going to open more cases, look at more issues. Large business, for instance. You know, every major corporation has an audit every year. We're now going to be able to look at more issues and go deeper into issues and some of the things in your legislation should allow us some more time to go deeper.

And then on partnerships. You know, right now we audit a partnership -- a partnership is usually a web of multiple, sometimes hundreds of partners. We'll use those resources and the new people we have to be able to look further through -- actually trace the money so that we're looking at the whole economic picture, not just the entity, which we're doing a tax return. And so it's really people, technology, do our job better.

The measures that we will use -- we've got our traditional measures: coverage, case closures, audit by type, enforcement dollars. We clearly, the president has set out a five-to-one return -- or depending on where the money's going for enforcement a seven-to- one return, a 13-to-one return. We going to need to monitor that.

I think we also need to work on measures around earlier identification of issues -- before I talk about foreign tax credit generators. We got on top of that. And so having better trained people, more of them, pursuing more issues, getting to issues earlier so we stop problems before they start. Those are somewhat intangibles. They're not going to show up in our traditional metrics, but they're things that we're going to need to look at.

And I guess the last thing I'd say is as we develop measures, I'm very anxious to work with you and others on legislation, because depending on what kind of new tools we get, we'll be able to have a much higher bar for ourselves to go after.

SEN. BAUCUS: (Off mike.)

MR. SHULMAN: I just wanted to answer -- international. A significant portion will be international. As you know, the president set out $210 billion -- a combination of policy and enforcement. And frankly, there's only -- you know, we're going to take year after year pretty much as many resources as we can absorb into the international arena, get trained and get up to speed in that year and continue focusing there.

I actually, last October 1, when we were under a budget freeze and were basically under a hiring freeze, took some attrition money from other areas and put it into international, because I thought it was so important that we continue to invest in that area and not fall behind.

SEN. BAUCUS: Okay.

I guess -- there are a lot of pretty bright people out there trying evade taxes -- a lot of preparers, tax lawyers, others.

Do you feel when you hire that you'll be able to hire people of sufficient competence and talent and expertise and know how all of these taxes being evaded?

MR. SHULMAN: Yeah, we've talked before, Mr. Chairman.

One of my highest priorities is our work force -- getting the right people, training them, making sure they're motivated, making sure they have the right tools. I actually have a centralized unit that's reporting directly to me to revamp a variety of work force efforts.

For our hiring, we've now pulled it out of the business units and are centralizing our hiring infrastructure. I think one of the -- I wouldn't call it silver linings -- but one of the realities in this economic downturn is that we've got time right now. We're getting more applicants for every opening than we've ever gotten in our history. I mean, incredibly qualified people.

So I plan to take advantage of this.

SEN. BAUCUS: That may be true and there may be an opportunity -- a major opportunity there.

I've run across this in several different circumstances. In fact, I was talking to one of the top lawyers in the Obama administration. And he said, you know, they thought that after the president was elected they'd get a lot of applicants for jobs and show up and very talented people. He was wrong. He was flooded by applicants. People with just much more talent -- and these are the brightest people one could possibly hope for.

Second, I was talking to the president of Harvard University not too long ago and she said, you know, it's amazing. You know, not too many years ago -- I don't know what school it was, if it was Harvard College or maybe it was some other unit -- a large majority wanted to go to Wall Street, because that's where the money was and they loved -- but she said, frankly, that a lot of people really didn't -- they're going because there's peer pressure to go.

But now that Wall Street is sort of on the downside, a lot of the students said, gee, that's great, because I didn't really want to do that anyway. You know, I want to go do public service. I want to go to Africa. I want to go help people and help do these things.

And then I'm running into it, you know, anecdotally. People on Wall Street and elsewhere are saying, hey, now I don't have to chase the dollars as much -- there was too much pressure to chase the dollar -- and now I can do some things that I kind of want to do.

So I think there's a real opportunity here. People -- a lot of people want to serve. They care about our country. They want to help serve our country. And I just encourage you to take advantage of that and get the best and brightest -- and they've got their heads on straight too, because they're doing their work.

But thank you, Commissioner, very much. I think you're doing a real good job and we'll just keep working together to address some of these problems.

MR. SHULMAN: We need all the support.

SEN. BAUCUS: Hearing's adjourned.

END.


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