The Internal Revenue Service IRS and the U.S. Department of the Treasury are intensifying efforts to combat a tax evasion strategy that has been costing the government substantial revenue.
This tactic, known among officials as the “shell game,” involves shifting money and assets between related entities to conceal taxable income and reduce tax obligations for large corporate conglomerates.
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What Does the IRS Mean by the “Shell Game”?
The “shell game” refers to a series of tax maneuvers involving asset transfers and transactions between affiliated companies and entities without legitimate economic purpose, primarily aimed at generating tax deductions and minimizing tax liabilities.
According to recent statements by Wally Adeyemo, Deputy Secretary of the Treasury, these practices are designed solely to evade taxes by employing complex techniques to move assets from one entity to another.
This week, officials released a new set of guidelines and warnings against this tactic, aiming to alert companies about increased scrutiny and the consequences of deceiving the system. Government estimates suggest that addressing this form of tax evasion could recover up to $50 billion over the next decade.
A New Era in Corporate Tax Enforcement
This initiative is part of a broader strategy the IRS has been developing since receiving additional funding from the Inflation Reduction Act of 2022. With this new budget, the IRS has been able to enhance its audit and enforcement capabilities, particularly focusing on wealthy taxpayers and large corporations.
To date, the IRS has initiated audits of 76 major partnerships, including hedge funds, law firms, and real estate investment trusts.
These audits are complex due to the nature of partnerships, where profits and losses are passed through to the underlying partners, who are often other entities, creating a complicated web of entities that is difficult to untangle.
The Importance of Greater Tax Transparency
Historically, the low audit rate of these pass-through businesses, where only about 0.1% of returns were reviewed in 2019, has been a point of criticism and concern. However, with the new resources and approaches, the IRS plans to audit 1% of these entities’ returns by 2026, marking a significant shift in enforcement policy.
IRS Commissioner Danny Werfel has pointed out that these “tax shelters” have allowed wealthy taxpayers to avoid paying their fair share, uncovering tens of billions of dollars in questionable deductions related to the shifting of tax bases.
Tax bases, which typically represent the capital investment in a property, can be manipulated to move between entities that can benefit from deductions while others cannot.
To counteract these maneuvers, the IRS and the Department of the Treasury are preparing a series of regulations that will prevent the shifting of tax bases between related entities and provide the tax agency with greater visibility into the internal operations of these large corporations. These regulations are designed not only to close tax loopholes but also to make complex corporate structures more transparent.