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The Internal Revenue Service is investigating hedge funds' use of swaps and stock loans to dodge taxes, and the IRS is promising to crack down on abusive schemes.

IRS Commissioner Doug Shulman told a Senate panel Thursday that Wall Street firms and hedge funds shouldn't assume that he will allow the transactions just because his predecessors had ignored them.

"Investors should give up the notion of the Wall Street rule — that if we haven't looked at something before, we won't look at it now," Shulman testified to the Senate Permanent Subcommittee on Investigations. "We will challenge sham transactions that have no economic purpose other than tax avoidance."

The subcommittee Thursday released the results of a yearlong investigation that concluded Wall Street firms concocted derivatives and stock-loan deals to help offshore hedge funds dodge hundreds of millions of dollars in U.S. taxes.

The report said the IRS looked the other way while securities firms including Lehman Brothers Holdings Inc., Merrill Lynch & Co. and Morgan Stanley sold complicated financial products designed to skirt a law requiring them to withhold U.S. taxes on stock dividends paid to offshore investors.

Subcommittee Chairman Carl Levin, D-Mich., criticized the IRS, saying the agency failed for 10 years to make clear that it is illegal to use derivatives simply to avoid tax. He asked Shulman to make a clear statement to that effect Thursday, and Shulman refused.

"If the IRS tells them to stop, they would stop," Levin told Shulman. "The IRS won't say stop and won't say go. Everyone is waiting for the IRS to make up its mind."

Levin said he wants the IRS to pursue back taxes or penalties against the firms that created and marketed the so-called "dividend enhancement strategies" and their hedge-fund clients that got around a 30 percent dividend tax.

The dividend tax applies to offshore investors who don't pay U.S. taxes on interest or capital gains. The 30 percent rate generally applies only to investors based in countries that don't have a tax treaty with the United States, Levin said.