Executive Summary

Objective and Scope

Background

Results

Conclusion

Appendix I – Detailed Objective, Scope, and Methodology

Appendix II – Major Contributors to This Report

Appendix III – Report Distribution List

Appendix IV – Outcome Measures

Appendix V – Management’s Response to the Draft Report

Executive Summary

The Earned Income Tax Credit (EIC) is a refundable credit created in 1975 to offset the impact of Social Security taxes on low-income families and encourage them to seek employment rather than welfare. The Congress assigned responsibility to the Internal Revenue Service (IRS) to administer the EIC. The IRS defined this role as ensuring the efficient administration of the law; achieving full participation of eligible taxpayers; and reducing overclaims and fraud, waste, and abuse.

The EIC is technically treated as a payment and is refundable even if no tax liability exists. This has led to significant compliance problems. An IRS study using Tax Year (TY) 1994 tax returns estimated taxpayers overclaimed $4.4 billion in EIC, or 25.8 percent of the total EIC amount claimed in TY 1994. The Congress has been concerned with the effectiveness of the IRS to both achieve full participation by taxpayers who qualify for the credit and reduce EIC overclaims. In 1997, the Congress provided the IRS with a special 5-year, $716 million appropriation for the improved application of the EIC. The objective of this audit was to determine if the IRS had an effective process to assess the use and impact of the EIC appropriation.

The IRS needs to improve its process for reporting on the use and measuring the impact of the $297 million already spent and the remaining EIC appropriation funds it plans to spend on initiatives designed to improve EIC compliance. However, we found that the IRS has implemented some initiatives aimed at improving compliance and established a process to track the expenditure of funds from the EIC appropriation. The IRS also created the EIC Program Office in May 1998 to coordinate its EIC compliance initiatives.

The IRS does not have procedures to validate the accuracy of the information it provides quarterly to the Congress. Specifically, the EIC Program Office does not validate the information it receives from other IRS functions to ensure it is accurate and reliable.

The information reported on workload results in the IRS Tracking Earned Income Tax Credit Appropriation Annual Report - FY 1999 was inaccurate and unreliable. Without validating the accuracy and reliability of the information, IRS management cannot reasonably assure the information reported to the Congress is complete, accurate, and reliable for assessing how the IRS is spending the EIC appropriation funds or for making future budget decisions.

The Congress directed the IRS to measure the effect of the expenditure of funds on improving EIC compliance and report quarterly on the rate of change. The IRS has conducted several studies to measure EIC compliance, but none has established a reliable baseline. The IRS is currently developing a baseline using TY 1997 returns and has begun a compliance study on TY 1999 returns.

As of April 2000, the IRS was unable to measure improvements in EIC compliance for the approximately $297 million it had spent on improving the application of the EIC. It can report results only on the amount of revenue protected or collected and workload completed. Without a process to assess the impact of EIC initiatives, neither the IRS nor the Congress can determine if the IRS’ use of the $716 million EIC appropriation is improving EIC compliance.

The IRS has implemented several initiatives aimed at improving the application of the EIC. These efforts include improving taxpayers’ awareness of EIC eligibility and continuing efforts to identify and stop inappropriate EIC claims before refunds are issued.

The IRS tracks the expenditures for EIC-related work in various information systems. The expenditure data are rolled up monthly to the IRS’ financial system and are included in the IRS’ quarterly report to the Congress. During our review of the expenditures reported by the IRS to the Congress for the first quarter of FY 2000, we found a $9 million discrepancy between the expenditures reported and those posted to the AFS as of January 31, 2000. IRS management was aware of the discrepancy, which was caused by a delay in posting due to modifications being made to the AFS. These expenditures were eventually posted to the AFS. While there was no apparent negative impact caused by this delay in posting EIC expenditures to the AFS, future delays in posting of expenditures could result in the IRS making poor financial management decisions.

The Wage and Investment Division should measure the impact of EIC initiatives in improving EIC compliance and ensure the information reported to the Congress is complete, accurate, and reliable.

Management’s Response: IRS management agreed with our recommendations and concurred with the outcome measures presented in Appendix IV. In its response, the IRS pointed out that the then-pending IRS reorganization last fiscal year made it difficult to manage the multi-functional, cross-divisional EIC program. In response to our recommendation to establish a process to ensure workload results reported to the Congress are complete, accurate, and reliable, the IRS plans to require and review supporting documentation from all functions for all workload results reported. Because several studies and reports have been completed relative to the EIC filing population since the end of our work on this audit, and one of these studies is a series intended to measure changes in filing behavior, the IRS does not plan to take additional corrective action to our second recommendation (that it should effectively measure the impact of the EIC initiatives on improving EIC compliance).

Objective and Scope

The overall objective of the review was to determine if the Internal Revenue Service (IRS) had an effective process to assess the use and impact of the Earned Income Tax Credit (EIC) appropriation. To accomplish this objective, we:

• Identified the various initiatives funded out of the EIC appropriation and determined if they met Congressional intent.
• Evaluated the methods used to track the expenditure of funds from the EIC appropriation.
• Determined whether the IRS developed an effective process for tracking the results of the EIC initiatives.

We performed our work at the IRS National Headquarters between January and June 2000. Our review was performed in accordance with the President’s Council on Integrity and Efficiency’s Quality Standards for Inspections.

Details of our objective, scope, and methodology are presented in Appendix I. Major contributors to this report are listed in Appendix II.

Background

The EIC is a refundable credit created by the Congress in 1975 to offset the impact of Social Security taxes on low-income families and encourage them to seek employment rather than welfare. This credit provides a major source of assistance to low income families. Since the inception of the credit, EIC law and administration have grown increasingly complex. For example, the IRS has gone from the use of a single line on the individual income tax return for the EIC to a publication and schedule devoted to EIC instructions and computations for claiming the credit. The amount of the allowable credit has expanded from a maximum of $400 in Tax Year (TY) 1975 to $3,816 in TY 1999. The number of taxpayers claiming the EIC increased from 6.2 million in TY 1975 to 19.4 million in TY 1998 ($1.25 billion in EIC claimed in TY 1975 to over $30 billion in 1998). During the same period, the average credit increased from $202 to $1,577.

The Congress gave the IRS the authority to administer the EIC. The IRS has defined this role as ensuring the efficient administration of the law; achieving full participation of eligible taxpayers; and reducing overclaims and fraud, waste, and abuse.

The EIC is technically treated as a payment and is refundable even if no tax liability exists. This has led to significant compliance problems. A study conducted by the IRS, using TY 1994 tax returns, estimated taxpayers overclaimed $4.4 billion in EIC, or 25.8 percent of the total EIC amount claimed in TY 1994. The Congress has been concerned with the effectiveness of the IRS to both achieve full participation by taxpayers who qualify for the EIC credit and reduce EIC overclaims. In 1997, the Congress provided the IRS with a special 5-year, $716 million appropriation for the improved application of the EIC. Starting in Fiscal Year (FY) 1998, the funding was to be appropriated as follows:

Not more than:

• $138 million for FY 1998.
• $143 million for FY 1999.
• $144 million for FY 2000.
• $145 million for FY 2001.
• $146 million for FY 2002.

Results

The IRS needs to change its process for reporting on the use and measuring the impact of the $297 million already spent and the remaining EIC appropriation funds it plans to spend on initiatives designed to improve EIC compliance. However, we found that the IRS has implemented some initiatives aimed at improving compliance and established a process to track the expenditure of funds from the EIC appropriation.

The IRS created the EIC Program Office in May 1998 to coordinate the IRS’ EIC compliance initiatives. This office oversees the EIC Program budget and Program planning process; monitors the execution of all EIC activities; ensures the multidimensional aspects of this program are consistent, accurate, and comprehensive; and provides recommendations and decisions to enhance the EIC Program. In FY 2000, the IRS budgeted approximately $775,000 for the operation of the EIC Program Office.

Inadequate Validation of Information Causes Inaccurate Reporting of the Use of Earned Income Credit Appropriation Funds to the Congress

The IRS does not have procedures to validate the accuracy of the information it provides quarterly to the Congress. Specifically, the EIC Program Office does not validate the information it receives from other IRS functions to ensure it is accurate and reliable.

We found that the information on workload results in the IRS Tracking Earned Income Credit Appropriation Annual Report - FY 1999 was inaccurate and unreliable. For example, three of the five IRS functions either overstated or understated the workload results reported in the FY 1999 report. One function overstated the number of EIC cases by approximately 29 percent (1,015 of 3,498 cases). A second function overstated the number of notices sent to taxpayers by approximately 23 percent (155,000 of 680,000 notices). A third function did not report the fourth quarter workload results, and the third quarter results were incorrectly repeated in the fourth quarter. The functional areas provided inaccurate information because they did not validate their workload results prior to sending them to the EIC Program Office.

Several IRS functional areas (e.g., Customer Service, Criminal Investigation, District Office Examination, Office of Research, and Appeals) participating in EIC initiatives produce the workload results, such as the volume of EIC telephone calls received, tax returns prepared, and taxpayers assisted. This information is provided to the EIC Program Office monthly by the various IRS functions and is rolled into the IRS’ quarterly report to the Congress without validation of the information reported. Based on the Standards for Internal Control in the Federal Government, control activities should ensure that all transactions are completely and accurately recorded.

Without validating the accuracy and reliability of the information, IRS management cannot reasonably assure the information reported to the Congress is complete, accurate, and reliable for assessing how the IRS is spending the EIC appropriation funds. This could also cause errors in future budget decisions such as the under- or over-funding of EIC activities based on cost/result assessments of the activities.

Management’s Response: The IRS pointed out that the then-pending IRS reorganization last fiscal year made it a difficult time for managing the multi-functional, cross-divisional EIC program. To address our concern, the IRS responded that, "On a monthly basis, the EITC Program Office will request from all appropriate functions copies of the supporting documentation the functions have gathered to support their EITC workload results. EITC Program Office staff will review this documentation to ensure the results reported by the functions are accurate."

Incomplete Measurement of Initiative Results Leaves the Internal Revenue Service Unable to Determine Its Impact on Compliance

As of April 2000, the IRS was unable to measure improvements in EIC compliance for the approximately $297 million it had spent on improving the application of the EIC. It can report results only on the amount of revenue protected or collected and workload completed. For example, in the first quarter of FY 2000’s IRS Tracking Earned Income Tax Credit Appropriation report to the Congress, the IRS reported $75.7 million in revenue.

The Congress directed the IRS to measure the effect of the expenditure of funds on improving EIC compliance and report quarterly on the rate of change. However, the IRS has been unable to provide this information. The General Accounting Office (GAO) stated in a report on an IRS TY 1994 EIC Compliance Study that the IRS could be into its fourth year of the 5-year appropriation before it has study data for establishing a baseline and is able to conduct a follow-up study against which to measure change.

The IRS has conducted several studies to measure EIC compliance, but none has established a reliable baseline. The IRS is currently developing a baseline using TY 1997 returns and has begun a compliance study on TY 1999 returns.

Without an effective process for assessing the impact of the EIC initiatives on compliance, neither the IRS nor the Congress can determine if the IRS’ use of the $716 million EIC appropriation is improving EIC compliance.

2. The Wage and Investment Division should effectively measure the impact of the EIC initiatives on improving EIC compliance.

Management’s Response: The IRS pointed out that, since the end of our audit work and the issuance of this report, two significant reports have been issued relative to the entire EITC population. One of these is an ongoing series intended to provide a measurement of taxpayer’s changed filing behavior. As a result, the IRS does not believe additional corrective action is necessary.

Some Compliance Initiatives and a Process to Track the Spending of Funds Have Improved the Application of the Earned Income Credit

The EIC Program Office has a strategic planning process that entails evaluating recommendations for initiatives submitted by IRS functions. The process also includes evaluating taxpayer return filing history and the results of IRS research. The EIC Program Office, along with the Commissioner, Wage and Investment Division, determines whether to fund the initiatives out of the EIC appropriation based on the results of their evaluation. The initiatives agreed upon are included in the EIC Strategic Plan.

The IRS has implemented several initiatives aimed at improving the application of the EIC. These efforts include:

• Improving taxpayer awareness of EIC eligibility by enhancing the national EIC campaign to support local offices’ marketing and promotional efforts.
• Assisting taxpayers in determining if they are eligible for the EIC by providing them with quality customer service through toll-free telephone assistance 24 hours a day, 7 days a week.
• Continuing efforts to identify and stop inappropriate EIC claims before refunds are issued.
• Sending pre-filing season letters to taxpayers who made errors on their 1998 returns by either claiming a dependent who was also claimed by another taxpayer or providing information on their returns that indicated their qualifying child exceeded the age limit.
• Identifying questionable EIC claims, EIC-based refund schemes, and tax return preparers who prepare questionable EIC returns.

These initiatives are funded out of the EIC appropriation. The IRS established guidelines for identifying and recording the expenditures. To track how the funds are spent, specific codes are assigned to the work performed by personnel conducting the EIC-related work. IRS functions input the costs incurred for the month to their various information systems. The expenditure data are rolled up monthly to the IRS’ financial system and are included in the IRS’ quarterly report to the Congress.

During our review of the expenditures reported by the IRS to the Congress for the first quarter of FY 2000, we noted a $9 million discrepancy between the expenditures reported for 1 IRS function and the expenditures posted to the AFS for that function as of January 31, 2000. IRS management was aware of the discrepancy and informed us that the understatement occurred at the time because the AFS was being modified. This caused a delay in posting some data.

As a result, over 200 staff years and $9 million that were expended by the function did not timely post to the AFS. These expenditures were eventually posted to the AFS by March 31, 2000. Although there was no apparent negative impact caused by this delay in posting EIC expenditures to the AFS, future delays in the posting of expenditures could result in the IRS making poor financial management decisions.

Conclusion

The IRS and the Congress do not have a clear and accurate picture of the return on investment for the $297 million spent through December 31, 1999, on improving the administration of the EIC. Without complete, accurate, and reliable information on the results, neither the IRS nor the Congress can make informed decisions about the effective use of the EIC appropriation.

This could also affect how well the appropriation funds are being managed in terms of assessing resource and budgetary needs to effectively implement both current and future initiatives.

Detailed Objective, Scope, and Methodology

The overall objective of this audit was to determine if the Internal Revenue Service (IRS) had an effective process to assess the use and impact of the Earned Income Tax Credit (EIC) appropriation. Specifically, we:

1. Reviewed the appropriation law and determined the Congressional intent for the EIC appropriation.
2. Reviewed policies, procedures, and other documentation relating to the establishment of the EIC initiatives and determined if these initiatives met Congressional intent.
3. Reviewed available documentation to determine the functional areas involved in implementing the EIC appropriation and their respective roles and responsibilities.
4. Reviewed completed compliance research projects to determine if a baseline had been established and if compliance had improved as a result of the EIC initiatives.
5. Interviewed IRS personnel (within and outside the EIC Program Office) to identify specific roles and responsibilities.

2. Evaluated the methods used to track the expenditure of funds from the EIC appropriation.

1. Reviewed the EIC Program Office policies and guidelines for tracking the expenditure of funds to determine whether the methodology was consistent and appropriate.
2. Reviewed reports and other documentation establishing the expenditures for EIC initiatives and validated the data to determine whether it was accurate and reliable.
3. Interviewed IRS personnel involved with the EIC (within and outside the Program Office) to determine what processes were used to track expenditures to ensure accurate accounting of funds.

2. Determined whether the IRS developed an effective process for tracking the results of the EIC initiatives.

1. Reviewed the EIC Program Office’s policies and guidelines for capturing data reporting results to determine whether the methodology was consistent and appropriate.
2. Reviewed documentation regarding the EIC to determine whether appropriate long-term goals, objectives, and measurements had been established.
3. Reviewed available documentation to determine the process used to develop the EIC initiatives and evaluated the results to determine whether the process was effective.
4. Interviewed IRS personnel involved with the EIC (within and outside the Program Office) to determine what processes were used to monitor and validate initiatives and gathered information on the significance, relevance, and accuracy of any results provided.

Major Contributors to This Report

Walter E. Arrison, Associate Inspector General for Audit (Wage and Investment Income Programs)

Michael Phillips, Director

Debra Gregory, Audit Manager

Patricia Lee, Audit Manager

Dan Adams, Senior Auditor

S. Kent Johnson, Senior Auditor

Sharon Summers, Senior Auditor

Thomas Dori, Auditor

Bobbie Draudt, Auditor

Eleonor Lindner, Auditor

Peter Stoughton, Auditor

Report Distribution List

Commissioner N:C

Chief Financial Officer N:CFO

Earned Income Tax Credit Project Manager W:EITC

Director, Legislative Affairs CL:LA

National Taxpayer Advocate TA

Office of Management Controls N:CFO:F:M

Office of the Chief Counsel CC

Director, Office of Program Evaluation and Risk Analysis N:ADC:R:O

Director, Strategy and Finance W:S

Audit Liaison:

Earned Income Tax Credit Program Office W:EITC

Outcome Measures

This appendix presents detailed information on the measurable impact that our recommended corrective actions will have on tax administration. These benefits will be incorporated into our Semiannual Report to the Congress.

Type and Value of Outcome Measure: Reliability of Information – Actual; 1,015 Earned Income Credit (EIC) cases and 155,000 notices; see page 4.

We computed the 1,015 over-reported EIC closed cases by recalculating the number of EIC cases closed by one function for Fiscal Year 1999, using its management information system. We identified these cases based on the period they were closed and the EIC project code associated with the case. We compared these results, 2,483 EIC closed cases, to the number of EIC closed cases (3,498) reported by the function to determine the overstatement.

We computed the 155,000 overstated notices sent to taxpayers by another function as follows. First, we took 35 percent (the approximate EIC portion) of the total number of Duplicate Social Security Number (SSN) notices mailed in January 1999 (1.5 million). We then compared this amount, 525,000, to the 680,000 Duplicate SSN notices reported by the function. The difference totaled 155,000 notices, the amount overstated by that function.

Management’s Response to the Draft Report

The response was removed due to its size. To see the complete response, please go to the Adobe PDF version of the report on the TIGTA Public Web Page.