This report presents the results of our audit to determine if the Internal Revenue Service (IRS) ensured that taxpayers provided required documentation to justify Earned Income Credit (EIC) claims during audits.

Background

Earned Income Credit Was Allowed to Taxpayers Who Did Not Provide Required Documentation to Justify These Claims

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 – Case Examples

Appendix VI – Management’s Response to the Draft Report

Background

The Earned Income Credit (EIC) is a refundable tax 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 effective administration of the law; achieving full participation of eligible taxpayers; and reducing overclaims and fraud, waste, and abuse. In Calendar Year (CY) 2000, a total of 19,226,015 taxpayers received the EIC.

The IRS selects a taxpayer’s return with an EIC claim for audit when there are questions on whether the taxpayer is entitled to the claim. During an EIC audit, a taxpayer is required to provide the IRS with documentary evidence to prove his or her entitlement to the EIC claim. In 1999, the General Accounting Office had reported that taxpayer documentation required to justify the claims for EIC varied among IRS Tax Processing Centers. As a result, the IRS took steps to improve its efforts to verify whether taxpayers were entitled to their EIC claims. Specifically, it revised forms available to taxpayers to include a list of items considered appropriate for supporting an EIC claim. The IRS also provided uniform guidance to its tax examiners for conducting audits with EIC issues.

While most EIC claims are not questioned by the IRS, it did complete 325,654 audits and recommended over $411 million in additional taxes where EIC claims were in question in Fiscal Year (FY) 2000. Audits of EIC claims represented 74 percent of the total audits completed by the IRS’ Remote Examination function during the fiscal year.

This audit was conducted at the Remote Examination National Headquarters and the Andover, Fresno, and Kansas City Tax Processing Centers from April to June 2001. This audit was performed in accordance with Government Auditing Standards. Detailed information on our audit objective, scope, and methodology is presented in Appendix I. Major contributors to this report are shown in Appendix II.

Earned Income Credit Was Allowed to Taxpayers Who Did Not Provide Required Documentation To Justify These Claims

Taxpayers are not always treated consistently during audits of their EIC claims. Our review of 280 taxpayer audits with EIC issues from 3 Wage and Investment (W&I) Tax Processing Centers found that 26 (9 percent) taxpayers were allowed $72,126 in EIC without having to provide all required documentation to justify these claims. For example, in 1 case, a taxpayer was allowed $3,816 in EIC even though he or she did not provide documentation to verify that the children being claimed for the EIC lived with the taxpayer as required. Instead, the tax examiner accepted a verbal statement from the taxpayer that the children did in fact reside with the taxpayer. See Appendix V for additional case examples.

The Internal Revenue Code (IRC) requires taxpayers to meet specific tests to show that a qualifying child being claimed for the EIC is of a certain age, is related to the taxpayer, and lived with the taxpayer during the tax year. Taxpayers are required to provide documentary evidence during an EIC audit proving that the tests required by the IRC have been met, including:

• A birth certificate of the child being claimed for the EIC to verify the age and relationship to the taxpayer.
• A Social Security card for the taxpayer, spouse, and qualifying children to ensure Social Security numbers are valid for work in the United States.
• Documentation of the qualifying child’s residency, such as school records, medical records, or childcare provider statements to confirm the child lived with the taxpayer.
• A listing of individuals who lived in the same home as the taxpayer to ensure that there is not someone else in the household who can claim the qualifying child/children and has a higher Adjusted Gross Income. If so, the original taxpayer cannot get the EIC.

IRS procedures require front-line managers to review audits (case reviews) to ensure consistency and accuracy. A case review is a review of an in-process or closed audit worked by a specific employee. Among other things, these case reviews assess whether the tax examiner obtained required documentation during the audit to support the allowance/ disallowance of the EIC claim.

Managerial case reviews were not performed adequately. Our review of 55 tax examiner Employee Personnel Files (EPF) found that:

• Six employees (11 percent) had no case reviews performed on their work during a 1-year period (April 2000 to April 2001).
• Eleven employees (20 percent) have not had a case review during CY 2001 (January to April 2001).
• Eight (15 percent) employees were not adequately reviewed according to local procedures.
• Thirty (55 percent) employees were reviewed consistent with local procedures.

Guidelines did not specify the numbers or frequency for the performance of managerial case reviews. Discussions with the three Tax Processing Centers we visited showed that only two of the three Centers had local procedures that required, at a minimum, one case review per employee per quarter.

For FY 2000, the IRS completed 325,654 audits of taxpayers where there were issues related to the EIC. For FY 2001, the IRS plans to complete 422,210 audits of taxpayers where there are concerns with the EIC. Without an effective process to obtain required documentation to support EIC claims, all taxpayers may not be consistently treated. Therefore, taxpayers could be allowed the EIC even when they have not provided the required documentation to justify the EIC claim.

Recommendation

The Commissioner, W&I Division, needs to:

1. Develop expectations that case reviews be completed, and establish a process to ensure these reviews are done timely.

Management’s Response: The Director, Exam Strategy and Selection Unit, will issue guidance on managerial case reviews. Adherence to this guidance will be verified through periodic reviews of employee personnel files during site operational reviews.

Detailed Objective, Scope, and Methodology

The overall objective of this review was to determine if the Internal Revenue Service (IRS) ensured that taxpayers provided required documentation to justify Earned Income Credit (EIC) claims during audits.

To accomplish our objective, we determined if the IRS had clear criteria and guidance for its employees to follow to ensure taxpayers provide required documentation to justify their EIC claims during correspondence audits.

1. To determine the minimum documentary evidence required to be provided by taxpayers to justify EIC claims during a correspondence audit, we interviewed National Headquarters Remote Examination function management and local Examination function management, Unit Managers, and Lead Tax Examiners in the three Tax Processing Centers we visited (Andover, Fresno, and Kansas City).
2. To determine if the IRS employees consistently followed required criteria and guidelines when deciding if documentary evidence required to justify taxpayer EIC claims were sufficient, we reviewed a random sample of 280 Remote Examination function cases closed between October and December 2000. Sampling was done by choosing the nth case, where n equals the number of closed cases divided by 100. These were Wage and Investment taxpayer cases that were audited for EIC issues and had a reply from the taxpayer. Cases were chosen and reviewed from the Andover, Fresno, and Kansas City Tax Processing Centers due to their high volume of closed cases. These 3 Tax Processing Centers closed a total of 12,625 cases during our sampling period.
3. To determine if EIC audit workpapers were managerially reviewed in an attempt to ensure consistency of taxpayer-provided documentation to support an EIC claim, we reviewed documentation of managerial case reviews for a random sample of 55 of the approximately 400 tax examiners from the 3 Tax Processing Centers we visited.

Major Contributors to This Report

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

Michael Phillips, Director

Russell Martin, Audit Manager

Edith Lemire, Senior Auditor

Mary Keyes, Auditor

Report Distribution List

Commissioner N:C

Director, Compliance W:CP

Director, Compliance Services W:CP:CS

Director, Exam Strategy and Selection Unit W:CP:ESSU

Director, Strategy and Finance W:S

Chief Counsel CC

National Taxpayer Advocate TA

Director, Legislative Affairs CL:LA

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

Office of Management Controls N:CFO:F:M

Audit Liaison:

Outcome Measures

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

Type and Value of Outcome Measure:

• Protection of revenue - Potential; $72,126 (see page 2).

Methodology Used to Measure the Reported Benefit:

We reviewed a judgmental, random sample of 280 Remote Examination function cases closed between October and December 2000. Sampling was done by choosing the nth case, where n equals the number of closed cases divided by 100. These were Wage and Investment taxpayer cases that were audited for EIC issues and had a reply from the taxpayer. Cases were chosen and reviewed from the Andover, Fresno, and Kansas City Tax Processing Centers due to their high volume of closed cases. Our sample review found 26 (9 percent) of the 280 cases did not have all of the required documentation to justify an EIC claim. EIC totaling $72,126 was granted to the 26 cases that had insufficient documentation.

Case Examples

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.