Changes to Processing Procedures and Line Descriptions on
the Form 1040 Would Reduce Erroneous Claims for Some Refundable Credits
June 2005
Reference
Number: 2005-30-090
This report has cleared the Treasury
Inspector General for Tax Administration disclosure review process and
information determined to be restricted from public release has been redacted
from this document.
June
3, 2005
MEMORANDUM FOR
COMMISSIONER, WAGE AND INVESTMENT DIVISION
FROM: Pamela J. Gardiner /s/ Pamela J. Gardiner
Deputy Inspector General for Audit
SUBJECT: Final Audit Report - Changes to Processing
Procedures and Line Descriptions on the Form 1040 Would Reduce Erroneous Claims
for Some Refundable Credits (Audit # 200430021)
This report presents the results of our
review to determine the number of
taxpayers that made erroneous claims on the “Other payments from:” line of the
U.S. Individual Income Tax Return (Form 1040), the reasons for these claims,
and any changes needed in Internal Revenue Service (IRS) forms and instructions,
processing procedures, or computer programs to help prevent future erroneous
claims and any associated refunds. We initiated this audit based on information
provided by the IRS Frivolous Filer Unit located at the
In
summary, we found that the misreporting of estimated tax payments and
other payments as refundable credits on Form 1040 is not widespread. However, it can and has resulted in some
significant erroneous refundable credits.
The largest refundable credit in a sample of tax returns included in our
review was $40,000. In most of the cases
in our sample, the erroneous refundable credit exceeded the amount of tax owed
and resulted in the taxpayer receiving an erroneous refund.
We identified two potential
reasons why these erroneous entries were made by taxpayers and/or went
uncorrected by the IRS. First, the
“Payments” section of Form 1040 and the corresponding instructions, which have
been in effect for over 10 years, may be confusing to some taxpayers. The “Other payments from:” line on the Form 1040 is not intended for claiming
payments; it is intended for claiming refundable credits. This may confuse some taxpayers because they
are looking for a line on which to report payments they have made or are making
with their tax returns. Additionally,
the section of the Form 1040 where the line is placed combines refundable
credits and payments, which may also confuse taxpayers. Second, current IRS processing procedures
designed to authenticate claims for refundable credits were not consistently
followed and need improvements to identify returns with erroneous amounts on
the “Other payments from:” line.
We recommended the Director, Tax Forms and Publications, Wage and
Investment (W&I) Division, change the title of the “Other payments from:”
line on Form 1040 to more accurately reflect that the line is for claiming certain
refundable credits (and not for claiming payments to the IRS) and change
instructions for this line to clarify that it is not for claiming payments made
to the IRS. We also recommended the Director,
Submission Processing, W&I Division, ensure employees are aware of and
follow instructions for properly processing claims for refundable credits and
change the instructions for researching taxpayer accounts when trying to
resolve unsubstantiated claims for refundable credits. We estimated these corrective actions would result
in revenue protection of approximately $3.9 million over 5 years.
Management’s Response: IRS
management generally agreed with the issues presented in our report and did
agree with the outcome to be realized by taking corrective actions. Management disagreed with two of our three
specific recommendations but agreed to take a different corrective action. IRS management agreed with our recommendation
to improve IRS employees’ awareness of the reported situation and took
immediate corrective action. Management
did not agree to change the title of the Form 1040 “Other payments from:” line or to
specifically state in the Form 1040 instructions that the line is not for
claiming estimated tax payments or any other payments made to the IRS. However, management did agree to add clarification
to the Form 1040 instructions for this line to reinforce that it is to be used
only for payments or credits resulting from those forms specified. Management’s complete response to the draft
report is included as Appendix VII.
Office of Audit Comment: We believe
the IRS’ alternative corrective action should reasonably suffice to reduce the
number of taxpayer errors.
Copies of this report are
also being sent to the IRS managers affected by the report
recommendations. Please contact me at
(202) 622-6510 if you have questions or Richard Dagliolo, Acting Assistant
Inspector General for Audit (Small Business and Corporate Programs), at (631) 654-6028.
Appendix
I – Detailed Objectives, Scope, and Methodology
Appendix
II – Major Contributors to This Report
Appendix
III – Report Distribution List
Appendix IV
– Outcome Measures
Appendix V – Page 2 of U.S Individual Income Tax Return (2004)
Appendix VI – Page 2 of U.S
Individual Income Tax Return (2003)
Appendix VII
– Management’s Response to the Draft Report
Taxpayers must pay Federal income taxes throughout the year as income is
earned. Generally, they pay their income
taxes through one of two methods. If the
taxpayers are employees, their employers most likely withhold income taxes from
their earnings and remit the withheld amounts to the Internal Revenue Service
(IRS). If the taxpayers do not pay their
taxes through withholding, they generally are required to pay estimated tax
payments throughout the year. People who
are self-employed generally pay their taxes this way.
Estimated tax payments post to taxpayers’ accounts on the IRS Master File
and are applied (along with any withheld taxes and refundable credits) to the
tax liabilities reported on the taxpayers’ U.S. Individual Income Tax Returns
(Form 1040). If the amounts of estimated
tax payments, withholding, and refundable credits are greater than the tax
liabilities, the differences are refunded to the taxpayers.
The “Payments” section of the Form 1040 (see Appendix V for Tax Year [TY]
2003 and Appendix VI for TY 2004) has a line for taxpayers to enter the amount
of their estimated tax payments when computing the amount of tax they owe (line
62 for TY 2003 and line 64 for TY 2004 returns). However, because the amounts paid as
estimated tax payments have already posted to the taxpayers’ accounts, the
estimated tax payments are applied against the taxpayers’ tax liabilities regardless
of whether the taxpayers record the payments on the Forms 1040.
This same section of the Form 1040 also has a line entitled “Other
payments from:” (line 67 for TY 2003 and line 69 for TY 2004). This line was created for taxpayers to claim certain
refundable credits. The line has check
boxes for taxpayers to indicate they are claiming the following refundable
credits: 1) Notice to Shareholder of
Undistributed Long-Term Capital Gains (Form 2439), 2) Credit for Federal Tax Paid
on Fuels (Form 4136), and 3) Health Coverage Tax Credit (Form 8885). In addition, a number of other “write-in” refundable
credits such as Claim of Right Credits or Credits for Tax-Free Covenant Bonds may
be claimed on this line by identifying the credit in the margin of the return
and attaching applicable schedules (if required).
Any amount reported on this line creates a specific transaction that posts
a credit to the taxpayer’s account; the credit is applied against any tax
liability reported on the taxpayer’s Form 1040.
The IRS computers define the transaction as a Generated Refundable
Credit Allowance, Transaction Code (TC) 766.
If the amount of the refundable credit is greater than the tax
liability, the difference is refunded to the taxpayer.
The IRS Frivolous Filer Unit in
After reviewing a sample of these returns, we determined the taxpayers
were making a line entry error by entering estimated tax payments or certain
other payments on the “Other payments from:” line instead of the line on which
they should have been reported, resulting in the taxpayers receiving credit
twice for the same payments.
We initiated a review to determine the extent of this problem, its cause,
and changes needed to prevent the generation of these erroneous refundable
credits.
This review was performed at the Frivolous Filer Unit at the
The misreporting of estimated tax payments and other payments as refundable credits on Form 1040 is not widespread. However, it can and has resulted in some significant erroneous refundable tax credits. The largest credit in our sample was about $40,000 and the largest credit in our identified population was over $98,000. In most of the cases in our sample, the erroneous refundable credit exceeded the amount of tax owed and resulted in the taxpayer receiving an erroneous refund. Fortunately, the IRS can take some relatively easy steps to minimize or eliminate this problem.
Using computer analyses, we identified 703 TY 2002 and TY 2003 individual income tax returns that met the following criteria:
We reviewed a statistical sample of 134 of these tax returns and determined that 70 (52 percent) had erroneous entries of at least $500 on the “Other payments from:” line that should have been corrected.
Further analysis of these tax returns indicated that taxpayers (or their tax preparers) were responsible for the erroneous entries on 63 of the 70 returns, and IRS employees had incorrectly entered data into IRS computers on the other 7 returns. In many cases, we determined that the amounts entered in error by taxpayers were actually one or more estimated tax payments they had made to the IRS. Other erroneous entries on the “Other payments from:” line included credit card payments made by taxpayers to pay their tax liabilities, remittances included with returns, and payments made with requests for extensions of time to file returns. Twenty-one percent of the 70 erroneous tax returns were prepared by paid preparers.
We identified two potential reasons why these erroneous entries were made or went uncorrected by the IRS.
The “Payments”
section of Form 1040 and the corresponding instructions may be confusing to
some taxpayers
The title of the line “Other payments from:” may be misleading. Although the purpose of the line is for reporting refundable credits, taxpayers may consider it a catchall line on which to enter any payment for which the taxpayer cannot find an appropriate line on the tax return. This is compounded by the fact the Form 1040 has no place to record a payment (credit card, check, or cash) made with the tax return.
Instructions for the “Other payments from:” line contain one sentence that guides the taxpayer to “Check the box(es) to report any credit from Form 2439, 4136, or 8885.” If the taxpayer has made a prior payment or is making a payment with the return and is looking for a line on the return to place the amount of the payment, he or she could misinterpret the instruction as meaning, ‘If you have a credit from one or more of these forms check the box(es). If you have another payment not from one of these forms, place the amount on this line and do not check any of the boxes.’ The instructions do not tell the taxpayer that other payments cannot be placed on the “Other payments from:” line. In some instances, we found taxpayers placing amounts on the “Other payments from:” line, leaving the boxes unchecked, and indicating the source of the payment (e.g., “credit card,” “prepaid tax,” “1040-V,” etc.).
IRS processing practices allow erroneous entries to go uncorrected
Current procedures require IRS employees to identify during initial processing tax returns on which taxpayers enter amounts on the “Other payments from:” line that exceed a certain amount but do not indicate the type of credit claimed and/or do not attach other forms required to claim the credit. In most cases, employees are instructed to correspond with these taxpayers to determine the reason for the entry on the “Other payments from:” line. The returns and associated tax accounts included in our sample showed no indication the required correspondence was sent.
During processing, IRS computers identify for further review by IRS employees all tax returns with an entry on the “Other payments from:” line that are not claiming fuel tax credits or are claiming fuel tax credits for amounts different from the amounts the computer calculates. If taxpayers are claiming one of the other credits listed on the “Other payments from:” line and have attached the appropriate form, IRS employees are instructed to allow the credit. Also, if taxpayers have entered any of the acceptable “write-in” credits in the margin, IRS employees are instructed to allow the credit(s). In some cases, we found IRS employees allowing the credit as long as the taxpayer entered anything in the margin. For example, as discussed earlier, we identified instances in which IRS employees accepted amounts on the “Other payments from:” line, with no boxes checked, and entries in the margins of “credit card,” “prepaid tax,” or “1040-V.”
In some instances, the amount on the “Other payments from:”
line is more than the threshold amount specified in the IRS processing
instructions, and the taxpayer has not checked a box indicating which credit he
or she is taking or entered one of the acceptable “write-in” credits in the
margin. In these cases, IRS employees
are instructed to research the taxpayer’s accounts for a payment amount
matching the amount on the “Other payments from:” line. If the employees find such a payment, the
entry on the “Other payments from:” line is to be moved to the correct line of
the tax return. Because the instructions
are to look for a single payment rather than one or more payments, IRS
employees were missing some of the erroneous entries. We found that 24 percent of the 70 erroneous
entries on the “Other payments from:” line in our sample were actually a
combination of 2 or more payments made by taxpayers. On the other hand, if the amounts entered on
the “Other payments from:” line are less than the threshold amount, the IRS
employees are instructed to take steps to allow the entries with no further
research.
The confusion created
by the Form 1040 and the problems with IRS processing resulted in erroneous refundable
credits on 70 of the 134 tax returns in our sample. Based on the results of our sample, we
estimate 366 of the 703 tax returns meeting our sample criteria contained
inaccurate entries on the “Other payments from:” line of Form 1040 for TYs 2002
and 2003, resulting in erroneous refundable credits of over $1.5 million (see
Appendix IV). The average amount of the
erroneous refundable credits in our sample was $4,275 and the largest was about
$40,000. The largest resulting erroneous
refund in our sample was over $14,000, and the largest erroneous refund in our
identified population was over $65,000. These
figures include only those taxpayers that met our specific criteria. It is reasonable to assume that many other
taxpayers made these errors or were confused by the “Other payments from:” line,
but their returns did not meet our criteria or their entries on the “Other
payments from:” line fell below the IRS’ threshold amount.
1.
The Director, Tax
Forms and Publications, Wage and Investment (W&I) Division, whose mission
is to create and improve tax forms, instructions, publications and other
documents to help taxpayers understand and meet their tax responsibilities,
should change the title of the “Other payments from:” line on Form 1040 to more
accurately reflect that this line is for claiming other refundable credits and
not for claiming payments made to the IRS.
Management’s Response: IRS management
agreed conditionally with this recommendation.
The Commissioner, W&I Division, believes the current title for Form
1040 line 69 is descriptive of the intended use. However, the Director, Media and Publications,
W&I Division, will add clarification to the instructions for this line to
reinforce that it is to be used only for payments or credits resulting from the
forms listed or specified in the instructions.
Office of Audit Comment: We
believe the IRS’ alternative corrective action should reasonably suffice to
reduce the number of taxpayer errors.
2.
The Director, Tax
Forms and Publications, W&I Division, should state in the instructions for
the refundable credit lines on Form 1040, or in a reminder on the Form itself,
that these lines are NOT for claiming estimated tax payments or any other payments
made to the IRS.
Management Response: IRS
management does not believe the instructions should be revised to state what
not to include on Form 1040 line 69 because it could lead taxpayers to assume
that, if the list of what not to include is limited, then there are unlisted
items that can be included. However, as
stated in management’s response to Recommendation 1, the Director, Media and Publications, W&I Division,
will add clarification to the instructions for this line to reinforce that it
is to be used only for payments or credits resulting from the forms listed or
specified in the instructions.
Office of Audit Comment: We
believe the IRS’ alternative corrective action for Recommendation 1 should
reasonably suffice to reduce the number of taxpayer errors and address this
recommendation.
3.
The
Director, Submission Processing, W&I Division, whose responsibility is providing oversight for the processing of paper
and electronic individual returns and related payments and refunds, should:
Management’s Response: The Director, Submission Processing, W&I
Division, has issued clarifying instructions to Submission Processing function employees
highlighting the requirements to initiate the required correspondence to
taxpayers claiming the credit without indicating the source. The clarifying instructions also delineate
the credits that are acceptable and advise employees researching the amounts on
Form 1040 line 69 to be mindful that the amounts claimed may be a combination
of payments.
Appendix I
Detailed Objectives,
Scope, and Methodology
The overall objectives of this review were to determine the number
of taxpayers that made erroneous claims on the “Other payments from:” line of
the U.S. Individual Income Tax Return (Form 1040), the reasons for these
claims, and any changes needed in Internal Revenue Service (IRS) education,
processing, or computer programming to help prevent future erroneous claims and
any associated refunds.
To accomplish our objectives, we:
I.
Identified and
evaluated controls to determine whether they were functioning properly to
identify and stop erroneous refunds issued as a result of erroneous claims for
refundable credits on the “Other payments from:” line of the Form 1040.
A.
Reviewed the Internal
Revenue Manual procedures for handling returns with additional payments entered
on the “Other payments from:” line without checking one of the three boxes
indicating the source of the payment.
B.
Determined whether the
controls in place at the time of the review should have stopped the generation
of the duplicate credits.
C.
Interviewed employees
in the Frivolous Filer Unit at the IRS Ogden Campus and employees in the Code
and Edit, Data Conversion, and Error Resolution functions at the IRS Fresno
Campus.
D.
Obtained available
documentation for claims for erroneous refundable credits that were identified
by the Frivolous Filer Unit, determined what control breakdowns allowed these
refunds to be issued, and reviewed the claims for trends or similar
characteristics.
E.
Determined whether control
procedures had been changed to prevent similar breakdowns from occurring.
F.
Determined the extent
to which erroneous claims for refundable credits were processed by the IRS
during Tax Years (TY) 2002 and 2003.
1.
Prepared computer
requests to identify erroneous refundable credits that posted to the IRS Master
File from TYs 2002 and 2003. To do this,
we identified tax returns that met the following criteria:
a)
The tax return had an
amount on the “Other payments from:” line.
b)
The associated tax
account on the Master File had a Transaction Code (TC) 766 for $100 or more.
c)
The tax account showed
some combination of payments made by the taxpayer equaling the amount of the TC
766.
2.
To verify the data we
received met our criteria, researched 31 accounts on the IRS Integrated Data
Retrieval System (IDRS) to confirm the data in the database were accurate.
3.
Examined a statistical
sample of 134 of the 703 taxpayers that were identified in our computer analysis. The sample was selected using a 95 percent
confidence level, 30 percent expected error rate, and a precision of +7
percent. We ordered and reviewed the tax
returns and researched the accounts on the IDRS to determine the cause of the erroneous
refundable credit.
II.
Reviewed the Form 1040
and the associated instructions to determine whether the Form and/or
instructions may be confusing to taxpayers, causing them to place the amount
for estimated tax and/or other payments on the wrong line of the return.
A.
Reviewed the Form 1040
“Other payments from:” line to determine whether the Form provides adequate
information about the amounts that should appear on the line.
B.
Reviewed Form 1040
instructions to determine whether they clearly inform taxpayers where to place
estimated tax or other payments on the return.
Appendix II
Major Contributors to This
Report
Philip
Shropshire, Acting Assistant Inspector General for Audit (Small Business and
Corporate Programs)
Richard J.
Dagliolo, Director
Parker
Pearson, Director
Kyle R. Andersen, Audit
Manager
Robert M. Jenness,
Acting Audit Manager
W. George Burleigh, Lead
Auditor
Lisa M.
Stoy, Senior Auditor
James Adkisson, Information Technology Specialist
Appendix III
Commissioner C
Office of the Commissioner – Attn: Chief of Staff C
Deputy Commissioner for Services and Enforcement SE
Deputy Commissioner, Wage and Investment
Division SE:W
Director, Customer Account Services, Wage and
Investment Division SE:W:CAS
Director, Customer Assistance, Relationships
and Education, Wage and Investment Division
SE:W:CAR
Director, Media and Publications, Wage and
Investment Division SE:W:CAR:MP
Director, Submission Processing, Wage and
Investment Division SE:W:CAS:SP
Director, Tax Forms and Publications, Wage
and Investment Division SE:W:CAR:MP:T
Chief Counsel CC
National Taxpayer Advocate
TA
Director, Office of Legislative Affairs CL:LA
Director, Office of Program Evaluation and Risk
Analysis RAS:O
Office of Management Controls OS:CFO:AR:M
Audit Liaison: Commissioner,
Wage and Investment Division SE:W
Appendix IV
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:
· Revenue Protection – Potential; $3.9 million over 5 years in erroneous refundable credits on 366 taxpayer returns (see page 3).
Methodology Used to Measure the Reported Benefit:
Using computer programs, we identified 703 Tax Year (TY) 2002 and 2003 taxpayer returns on the Internal Revenue Service (IRS) Individual Master File that met the following criteria:
·
The U.S. Individual
Income Tax Return (Form 1040) had an amount on the “Other payments from:” line.
·
The associated tax
account on the Master File had a Transaction Code (TC) 766 for $100 or more.
·
The tax account showed
some combination of payments made by the taxpayer equaling the amount of the TC
766.
We selected a statistical sample of 134 accounts from
the population of 703 accounts. Our
sample size was determined based on a 95 percent confidence level, an expected
error rate of 30 percent, and a precision of +7 percent. Of the 134 returns we reviewed, 70 received erroneous refundable
credits. The average erroneous credit
for the 70 returns reviewed was $4,275 per return. When this average amount was projected to 52
percent of the population of 703, it resulted in $1,564,650 in erroneous refundable credits generated
on taxpayers’ accounts for TYs 2002 and 2003.
Therefore, over 5 years the erroneous refundable credits would total $3,911,625. We estimate the number of returns affected
for TYs 2002 and 2003 totaled 366.
Appendix V
Page
2 of U.S Individual Income Tax Return (2004)
The form was removed due to its size. To see the form, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.
Appendix VI
Page 2 of U.S Individual Income Tax Return
(2003)
The form was removed due to its size. To see the form, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.
Appendix VII
Management’s Response to the Draft
Report
The response was removed due to its
size. To see the response, please go to
the Adobe PDF version of the report on the TIGTA Public Web Page.