The Earned Income Tax Credit (EITC) is one of the primary forms of public assistance for low income working taxpayers. However, the EITC is associated with a high improper payment rate. According to the Treasury Department’s Fiscal Year (FY) 2018 Agency Financial Report, the FY 2018 EITC improper payment rate is approximately 25 percent. A principal cause of the EITC improper payment rate is the complexity of the rules for claiming EITC, as reported by the Department of Treasury here and here. While I recognize the importance of tracking and minimizing improper payments, I am concerned that the focus on “a number” masks both the successes and challenges in improving EITC compliance. In fact, EITC improper payment estimates are based on audits of tax years four years in the past and do not reflect the most recent remedial measures. Additionally, the Treasury Inspector General for Tax Administration (TIGTA) reports that the EITC improper payment rate does not take into account that for every dollar of EITC improper payments, 40 cents of EITC went unclaimed by taxpayers who appear to be eligible for the credit.
In this year’s Annual Report to Congress I reported that IRS actions to reduce the EITC improper payment rate are not sufficiently proactive and may unnecessarily burden taxpayers. For instance, despite the acknowledged complexity of the rules for claiming EITC as a cause of improper EITC claims, IRS and Treasury legislative proposals to address EITC improper payments center on enforcement measures rather than on simplification.
Second, the IRS relies on the audit process as its primary compliance tool. In fact, in FY 2017, 35 percent of all individual returns selected for audit were selected on the basis of an EITC claim. This is despite the fact that EITC returns account for approximately 19 percent of all individual returns filed in calendar year 2016 and less than one percent of all individual returns filed were audited in FY 2017.
Additionally, the IRS and Treasury consistently recommend expanding the IRS’s math error authority (MEA) by conferring “correctible error authority.” In particular, this would allow the IRS to use MEA when the information provided by the taxpayer on his or her return does not match the information in government databases. I have regularly raised concerns with expanding MEA to include correctible error authority. For example, here, here, here, and here. There are particular problems with using correctible error authority to address mismatched information in government databases. The government database may not be reliable for tax purposes. Even if the entries in a directory were accurate, they were compiled for a different purpose, do not disprove eligibility under the tax law, were compiled at a prior date and may not be current. This is all important when considering that EITC cases involve complex and fluid fact patterns.
The IRS also exercises its authority under IRC § 32(k) to impose two-year bans on claiming EITC on taxpayers who claim EITC with “reckless or intentional disregard of rules and regulations.” The IRS imposed 3,442 IRC § 32(k) bans on taxpayers who claimed EITC on their 2017 returns. These approaches potentially make it more difficult for low income taxpayers, the recipients of the EITC, to receive EITC when they are eligible for it and may not necessarily improve the EITC improper payment rate. In 2013, TAS analyzed a representative sample of two-year ban cases and found that the IRS imposed the ban improperly almost 40 percent of the time in 2011. TAS will be revisiting this study to measure the correctness and impact of the IRS implementation of the two-year ban.
There is more the IRS could be doing to reduce the EITC improper payment rate while being less burdensome to taxpayers. First, the IRS should educate EITC taxpayers in a manner tailored to their specific circumstances. In 2016, TAS Research sent letters tailored to a population of EITC taxpayers that identified a specific error the taxpayer appeared to have made in claiming the EITC on his or her 2014 tax return. The letters also educated the taxpayer about the requirements for claiming EITC. Taxpayers who were sent the TAS letter were less likely to repeat the same error on their 2015 returns than unaudited taxpayers who did not receive TAS letters. Sending the TAS letter to all taxpayers whose 2014 returns appeared to be erroneous because the relationship test was not met would have averted about $47 million of erroneous EITC claims. That is a statistically significant improvement. On the basis of the 2016 results, the National Taxpayer Advocate revised the letters and sent them to taxpayers in representative samples in 2017. The results from 2016 were corroborated. However some letters in the 2017 study also included access to a dedicated toll-free EITC helpline, a recommendation I previously discussed that could help taxpayers trying to navigate the intricacies of complex EITC eligibility rules. Sending the TAS letter with the extra help phone number to all taxpayers whose 2015 returns appeared to be erroneous because the residency (not just the relationship) test was not met would have also averted more than $44 million in erroneous EITC claims.
And last, any attempts to improve the EITC improper payment rate must address the role that tax preparers play in EITC noncompliance. According to the IRS’s data, 54 percent of taxpayers claiming the EITC in filing season 2017 had their returns prepared by a paid preparer. In particular, research shows that EITC taxpayers most often use unenrolled return preparers. Unlike CPAs or enrolled agents, unenrolled agents have no previously recognized credentials. Unenrolled return preparers had the highest frequency and percentage of EITC overclaims in one IRS study, with 49 percent of those EITC returns containing an overclaim, and overclaims amounting to 33 percent of the total EITC claimed on those returns. I’ve recommended ways in which the IRS could protect taxpayers who rely on paid preparers. I’ve also testified before Congress about the high levels of noncompliant EITC returns prepared by unenrolled agents.
The EITC improper payment rate undoubtedly is a problem. However, since it is one of the largest sources of public welfare for low income taxpayers, the IRS needs to take an approach that balances the need to prevent improper payments with the need that all eligible taxpayers receive the credit. In addition to audits and IRC § 32(k) bans, the IRS should consider efforts to educate taxpayers about what errors they are making through tailored letters and by providing a toll-free helpline specifically staffed to answer EITC questions throughout the year. Last, given that many EITC taxpayers rely on unenrolled preparers, any effort to curb the EITC improper payment rate must address the role of unenrolled preparers.
Over the next three months, I have convened a team, including Les Book, Professor-in-Residence with TAS, and Margot Crandall-Hallick, on detail from the Congressional Research Service, to compile and explore research, analysis, and findings from the government, nonprofit, academic, and private sectors regarding improving both EITC compliance and participation. In my upcoming June Objectives Report to Congress, I will be submitting to Congress a report discussing our recommendations for addressing these important issues. Stay tuned!