TREASURY INSPECTOR GENERAL
FOR TAX ADMINISTRATION
Improvements Are Needed in the Earned Income Credit Recertification Program
Reference No. 2001-40-030
The Congress established the Earned Income Credit (EIC) in 1975 to help alleviate poverty and provide work incentives to low income taxpayers. The EIC affects a significant number of taxpayers, as demonstrated by the large number of taxpayers claiming the credit. For example, 19.4 million taxpayers claimed $30.6 billion in EIC on their 1998 tax returns.
Taxpayers can qualify for the EIC in two ways. The first involves "child-related" EIC, where taxpayers meet income requirements and have either one or two qualifying children. A qualifying child is a child (adopted, step, grand, foster) under age 19 (24 for full-time students). Taxpayers without qualifying children may qualify for "income-only" EIC if their income is below a certain level.
Historically, the EIC has been subject to abuse by taxpayers claiming credits they are not entitled to receive. As a result, the Congress passed legislation in 1997 requiring taxpayers whose EIC was denied during audits to prove their eligibility for the credit before they could receive the EIC again. This law is effective for tax years beginning after December 31, 1996.
In response to this legislation, the Internal Revenue Service (IRS) implemented the EIC Recertification Program in January 1999. When the IRS denies the EIC during an audit, a recertification indicator is placed on the taxpayerís account preventing the taxpayer from receiving future EIC unless the IRS and/or the taxpayer takes appropriate actions.
The objective of this review was to determine whether the IRSí EIC Recertification Program effectively addressed this legislation.
The IRSí EIC Recertification Program should reduce the amount of incorrect EIC allowed by the IRS. We estimate that, as of September 30, 1999, the IRS properly placed recertification indicators on 336,000 taxpayer accounts while denying, during audits, an estimated $620 million in EIC claims. While this is a noteworthy accomplishment, significant improvements are needed for the entire Program to operate effectively. Our review identified the following conditions that adversely affected the IRSí ability to safeguard revenue and ensure taxpayer rights with the least amount of burden to taxpayers:
These conditions occurred because the IRS did not always implement effective procedures for its employees to follow when processing Recertification Program cases. The IRSí quality assurance process also did not provide accurate feedback on the Programís performance. As a result, some taxpayers encountered delayed refunds, unnecessary audits, or non-receipt of their EIC. Other taxpayers may have received an EIC they were not entitled to. In addition, some taxpayers were recertified but not for the reason for which their EIC was initially denied.
The Internal Revenue Service Did Not Always Remove Recertification Indicators Accurately
The use of the recertification indicator is an important part of the IRSí process for ensuring that taxpayers prove their EIC eligibility. However, the IRS did not have a consistent process for ensuring that indicators were accurately removed. As a result, an estimated 11,400 taxpayers may have their future EIC claims incorrectly denied or audited because the indicators were not removed after the IRS allowed the EIC claimed by taxpayers. In addition, an estimated 4,100 taxpayers had their indicators removed incorrectly, which could result in these taxpayers receiving an EIC they are not entitled to on subsequent returns.
Some Suspended Refunds Were Not Released Timely
The IRS can suspend refunds while the EIC audit actions are pending. We estimate that the IRS had taken action to suspend any refunds on 91,000 Tax Year 1998 accounts that either had not been audited or for which the audits had been closed as of September 1999. To determine whether refunds were released timely, we selected a random sample of 200 of these accounts. Our analysis showed that 43 percent of these accounts had refund delays that ranged from 2 to 40 weeks and averaged 9 weeks.
Recertification Audits Were Not Always Timely Processed
The IRS should expeditiously complete Recertification Program audits so that taxpayers are brought into compliance with the EIC regulations, taxpayers who are entitled to their refunds do not have refunds unnecessarily delayed, and taxpayers do not file subsequent year returns prior to the audits being completed. Our analysis of selected EIC recertification audits at 3 IRS processing centers found that 57 percent of the returns had delays that ranged from 2 to 29 weeks and averaged 8 weeks.
Not All Recertification Determinations Were Accurate
Taxpayers who were previously denied the EIC are required to submit Information To Claim Earned Income Credit After Disallowance (Form 8862) with the next tax return they file that claims the EIC. The IRS should send returns with this form to the Examination function to determine whether the taxpayers are entitled to the credit. Our review identified indications that the IRS allowed the EIC to taxpayers who did not submit sufficient documentation to prove they were entitled to the credit.
Taxpayer Correspondence Could Be Improved
Correspondence used in the Recertification Program should explain how the Program works and what is required for taxpayers to prove their EIC eligibility. Some of the letters were incomplete or contained incorrect information, while others did not include important information about the Program. Additionally, letters were not sent to advise taxpayers that they might be entitled to income-only EIC.
The Internal Revenue Service Could Enhance the Recertification Program
In March 2000, the IRS issued procedures stating that qualified taxpayers who claimed income-only EIC and filed Forms 8862 would be considered recertified. Implementing these procedures will cause taxpayers to be recertified for reasons other than the initial EIC denial reason and enable taxpayers to receive the EIC related to a qualifying child in subsequent years without being subjected to recertification audits.
Summary of Recommendations
To improve the Recertification Program, the IRS should ensure that employees process recertification cases accurately and timely. Specifically, it should ensure that recertification indicators are accurately removed, audits are timely and accurately completed, taxpayer correspondence is accurate and complete, and its quality review process accurately assesses the Programís performance. In addition, the IRS should consider modifying this Program to ensure that taxpayers are recertified for the reasons for which their EIC was originally denied.
Managementís Response: The IRS agreed with 10 of our 12 recommendations. It did not agree with our recommendation to improve its quality review process. Instead, IRS indicated that the number of closed recertification cases is 1.4 percent of the total EITC cases closed and it would not be unusual that only five errors were identified nationwide. In addition, the IRS responded that the Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities) would address recommendation 12 of this report, along with its related outcome measure. As of December 20, 2000, we had not received this additional response. The IRSí comments are incorporated in the report where appropriate, and the full text of the response is included as Appendix VI.
Office of Audit Comment: While the IRS does have a quality assurance process in place, we believe that it should be improved to identify error trends or patterns specifically related to recertification cases. Also, while the IRS agreed with our recommendation to improve the taxpayer correspondence used in the recertification program, its response did not address four of the six letters requiring clarification.
While the IRS agreed with most of the outcomes presented in this report, it disagreed with the number of taxpayers affected by not properly reversing the recertification indicator (1,646 v. 11,400). We provided the IRS with the methodology, extract criteria, and actual cases in our sample to support our outcome measure. Our review of the IRSí analysis showed that its case selection criteria excluded several categories of closed recertification cases. For example, the IRSí selection criteria did not include Tax Year 1997 returns, Tax Year 1998 returns with non-examined disposal codes, or Tax Year 1998 returns closed as other than "No Change."