Administration of the Earned Income Tax Credit Program Has
Improved, but Challenges Continue
August 2005
Reference Number: 2005-40-133
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.
August
26, 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 - Administration of the
Earned Income Tax Credit Program Has Improved, but Challenges Continue (Audit #
200540012)
This
report presents the results of our review of the Earned Income Tax Credit
(EITC) Program. The overall objective of
this review was to assess the Internal Revenue Service’s (IRS) progress in
improving the administration of the EITC Program since Fiscal Year 2002. This review was a follow-up audit to a report
we issued in June 2003, in which we reported that long-term performance goals
and measures were needed and fragmented management reduced the effectiveness of
efforts to improve administration of the EITC Program.
The
EITC is a refundable credit available to taxpayers with certain amounts of earned
income to offset the impact of Social Security taxes on low-income families and
to encourage them to seek employment rather than welfare. Historically, the EITC Program has been
vulnerable to high rates of noncompliance.
The IRS has estimated between $8.5 and $9.9 billion (27 to 32 percent)
of the $31.3 billion in EITC claims made by taxpayers for Tax Year 1999 should
not have been paid. The IRS is in the
process of performing a National Research Program that will provide more
current data based on a sample of Tax Year 2001 income tax returns.
Progress
has been made in improving the administration of the EITC Program. The IRS has developed strategies and
initiatives that should improve both EITC Program participation and compliance
by taxpayers. The IRS has developed the
EITC Reform Initiative to address backlogs of EITC Program examinations,
minimize taxpayer burden during the audit process, improve communication with
taxpayers, increase outreach efforts, enhance compliance efforts, and pilot a
certification process for higher risk taxpayers.
In June 2003, we reported that
long-term performance goals and measures had not been established for the EITC
Program. The IRS has since established
long-term performance goals and measures to evaluate its progress in improving
the EITC Program. The long-term measures
are the percentage of Eligible Taxpayers Who File for the EITC and the percentage
of EITC Claims Paid in Error. Although
the IRS established the measures and goals, it had not updated these measures
since the measures were established.
The
IRS appointed an executive to head the EITC Office, who reports directly to the
Commissioner, Wage and Investment Division.
The executive still faces the difficulty of holding accountable the
functions that complete EITC Program work.
Most of these functions do not report to the EITC Office. For example, the Stakeholder Partnerships, Education,
and Communication function is responsible for education and outreach, and the
Field Assistance function is responsible for assistance with the
preparation of tax returns claiming the EITC and resolution of issues related
to EITC notices. Both of these functions
report to the Customer Assistance, Relationships, and Education function.
To
address this issue, the EITC Office developed Service Level Agreements that are
negotiated with each function involved in the administration of the EITC
Program. The Service Level Agreements document
and formalize the services being provided by the operating and functional divisions,
as well as the support the EITC Office will provide to the respective divisions. We believe this mechanism will increase the
accountability of functions with EITC Program responsibility, but the EITC
Office needs to ensure it regularly evaluates the effectiveness of the Agreements.
The
IRS continues to face other challenges in administering the EITC Program,
including the complexity of the tax law and the changing emphasis on the EITC
Program by both Congress and the Government Accountability Office. The EITC Program eligibility rules are
difficult and complicated for both taxpayers and the IRS. An analysis performed by the National
Taxpayer Advocate shows that many low-income taxpayers struggle to determine
EITC Program eligibility.
In
addition, the level of emphasis on the EITC Program is shifting toward
other areas of tax law enforcement.
Recently, both Congress and the Government Accountability Office
combined EITC Program concerns with the broader area of tax law
enforcement. With the changing emphasis
on the EITC Program, the EITC Office should be prepared to face the
possibility that it may have to operate with fewer funds yet continue to
produce a valuable product.
We
recommended the Director, EITC, closely analyze the results of the Service
Level Agreements. If the desired results
are not being achieved, the Director should consider elevating the level of
management that signs the Agreement.
Management’s Response: IRS
management agreed with our recommendation.
The EITC Office will monitor and analyze the results set out in the Service
Level Agreement with the Wage and Investment Division Compliance function as it
is implemented. As part of this process,
the EITC Office will evaluate the effectiveness of the Service Level Agreement
in facilitating the achievement of EITC Program objectives and will modify the
Service Level Agreement, including the level of management that signs the Agreement,
as necessary and appropriate. Management’s
complete response to the draft report is included as Appendix VI.
Copies of this
report are also being sent to the IRS managers affected by the report
recommendation. Please contact me at
(202) 622-6510 if you have questions or Michael R. Phillips, Assistant
Inspector General for Audit (Wage and Investment Income Programs), at (202)
927-7085.
Progress Has Been Made to Improve the Administration of the Earned Income Tax Credit Program
Long-Term Performance Goals and Measures
Were Established
Executive-Level Oversight of the Earned Income Tax Credit Program Was Established
Appendix
I – Detailed Objective, Scope, and Methodology
Appendix
II – Major Contributors to This Report
Appendix III – Report Distribution List
Appendix IV –
Earned Income Tax Credit Program Rules
Appendix V – Earned
Income Tax Credit Program Organization Chart
Appendix VI
– Management’s Response to the Draft Report
The Earned Income Tax Credit
(EITC) is a refundable credit available to taxpayers with certain amounts of earned
income. In 1975, Congress amended the
Internal Revenue Code to provide the EITC to offset the impact of Social
Security taxes on low-income families and to encourage them to seek employment
rather than welfare. For example, a working family with an income
of $25,000 is helped with the EITC because they may be eligible to claim from
$849 to $2,197, depending on the filing status and number of eligible children
in the family.
The Internal Revenue Service (IRS) is responsible
for administering the EITC Program.
Since 1975, additional legislation has been
passed in an attempt to clarify the qualifications for the EITC and make it
easier for more people to claim it. This
has made administration of the EITC Program more complex. The IRS has changed from the use of a single
line on the tax return for the EITC to a 53-page publication and schedule in
Tax Year (TY) 2004 devoted to EITC Program instructions and computations.
The number
of taxpayers claiming the EITC grew substantially from 1975 until 1995 but has since
remained relatively steady. The number
of taxpayers claiming the EITC increased from about 6.2 million in TY 1975 to 21.7
million in TY 2003. The total amount of
the EITC claimed increased from $1.2 billion to $38 billion. During the same period, the average credit
increased from about $202 to $1,754. Figures
1 and 2 present the total number of taxpayers claiming the EITC and the total
dollars claimed.
Figure 1 was removed due to its size. To see Figure 1, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.
Figure 2 was removed due to its size. To see Figure 2, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.
Historically, the EITC Program has been
vulnerable to high rates of noncompliance.
In February 2002, the IRS estimated
that, for TY 1999, between $8.5 and $9.9 billion (27 to 32 percent) of the
$31.3 billion in EITC claims made by taxpayers should not have been paid.
To
help improve administration of the EITC Program and reduce noncompliance,
Congress provided the IRS with a special appropriation for 5 years totaling $716
million for Fiscal Years (FY) 1998 through 2002. For FY 2003, Congress provided an additional
$146 million appropriation. These
separate appropriations allowed funds designated for the EITC Program to be
tracked separately from other enforcement funding. However, in FY 2004, the funds designated for
the EITC Program were merged into the general Tax Law Enforcement (TLE)
account. The EITC Program portion of the
TLE budget was almost $197 million in FY 2004.
The IRS participated in a joint Treasury-IRS task force to study EITC
Program noncompliance. In response to
recommendations made by the task force, the IRS has been testing different
concepts in its approach to noncompliance.
For example, the IRS is requiring a test group of higher risk taxpayers to
precertify their eligibility for the EITC.
These taxpayers must certify prior to receiving the EITC that they lived
with the children they claim for the EITC for the required length of time. The IRS also created an Executive Advisory
Council, made up of IRS executives involved in the administration of the EITC
Program, to help provide better oversight and coordination of the
administration of the Program.
The IRS is in the process of performing a National Research Program that will provide more current data based on a sample of 46,000 TY 2001 tax returns. The National Research Program will provide compliance measures for different types of taxes and different groups of taxpayers. Taxpayers that claim the EITC will be part of this Program.
The President’s Administration has made elimination
of improper payments a major focus of the President’s Management Agenda. Through the Improving Financial Performance
and Eliminating Improper Payments Program Initiatives, the President is holding
Federal Government agency managers accountable for strengthening financial
management controls so Federal agencies can better detect and prevent improper
payments and, thus, better ensure
taxpayer dollars are spent wisely and efficiently. In addition, in an effort to eliminate
improper payments, the President signed the Improper Payments Information Act
of 2002.
Federal Government agencies implemented
various requirements of the Improper Payments Information Act of 2002 in FY
2004. The results are captured in a
common reporting format in each agency’s Performance and Accountability
Report. The first year established the
baseline on which short- and long-term program improvement strategies and
priorities will be based.
Seven individual Federal Government programs
account for approximately 95 percent of the total IRS improper payments
reported in FY 2004. The EITC Program makes
up 21 percent of the total improper payments.
Figure 3 was removed due to its size. To see Figure 3, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.
This audit is a follow-up review to our report issued in June 2003 and
was conducted in the EITC Office of the IRS Wage and Investment (W&I) Division
in
The IRS has developed strategies and initiatives that should improve both EITC Program participation and compliance by taxpayers. The IRS developed an EITC Strategy in the FY 2003–2004 W&I Division Strategy and Program Plan. This Strategy was to implement a more comprehensive approach to the delivery of EITC Program services.
Subsequent to the development of the EITC Strategy, the IRS developed the EITC Reform Initiative. This Initiative addresses reducing backlogs of EITC Program examinations, minimizing taxpayer burden during the audit process, improving communication with taxpayers, increasing outreach efforts, enhancing compliance efforts, and piloting a certification process for higher risk taxpayers.
Several projects and initiatives have been developed that address the five points of the EITC Reform Initiative.
Audit process initiatives
To improve the existing audit process, the IRS has developed:
Compliance initiatives
To enhance compliance efforts, the IRS is continuing to refine tests and strategies. For example:
Outreach and education
initiatives
The IRS also implemented initiatives to increase its outreach efforts. For example:
Figure 4 was removed due to its size. To see Figure 4, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.
In 2003, we reported that long-term performance goals and measures had not been established for the EITC Program. Both we and the Government Accountability Office (GAO) reported the need for the IRS to develop long-term goals and measures. In addition, during part of the FY 2004 budget process, the Office of Management and Budget (OMB) assessed the EITC Program using its Program Assessment Rating Tool. The OMB gave the EITC Program an ineffective rating because of the significant amount of EITC Program noncompliance. While the IRS had a strong planning process closely linked to its budget process, it had not set performance goals that allowed it to demonstrate results or developed long-term performance goals for the EITC Program.
The IRS established two long-term measures to evaluate its progress and established goals for both measures. The long-term measures were:
Although the IRS established measures and goals, it had not updated either the percentage of EITC Claims Paid in Error or the percentage of Eligible Taxpayers Who File for the EITC since the measures were established.
Percentage of EITC
Claims Paid in Error
The most current estimate of EITC Claims Paid in Error continued to be between 27 and 32 percent. This figure was based on a study of TY 1999 returns completed in Calendar Year 2001. During our review, the IRS was in the process of performing a National Research Program that would provide more current data based on TY 2001 tax returns. The results of the National Research Program were not available at the time of this report.
The IRS has worked with the OMB and the Department of the Treasury to develop a methodology for estimating erroneous payments that is compliant with the Improper Payments Information Act of 2002. There are two areas for estimated error rates: the overall error rate and the estimated error rate for a particular high-risk component of the EITC Program, such as qualifying child. The OMB allowed the IRS to provide an estimated error rate for the qualifying child component because estimating the overall EITC Program error rate requires a full compliance study, such as the National Research Program, which takes several years to complete. The OMB allowed the IRS to estimate the error rate for the qualifying child component in the years between the compliance studies that provide estimates for the amount of EITC claimed.
Percentage of
Eligible Taxpayers Who File for the EITC
The most current estimate of eligible Taxpayers Who File for the EITC was 75 percent of the 17.2 million eligible taxpayers, based on a GAO study performed in December 2001 (see Figure 5). The IRS planned to employ the GAO methodology to estimate the percentage of eligible taxpayers who claim the EITC. However, the IRS informed us it was working to refine the methodology.
Figure 5 was removed due to its size. To see Figure 5, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.
In June 2003, we reported that administration of the EITC Program was fragmented, which diffused the accountability of the Program results. There was no executive appointed to head EITC Program efforts to provide accountability and recognition to the value and importance of the Program to both its internal and external stakeholders.
Federal Government management control standards require that agencies ensure appropriate authority, responsibility, and accountability are defined and delegated to accomplish the mission of the organization. The standards also require that an appropriate organizational structure be established to effectively carry out program responsibilities.
The EITC Office has been in a state of fluctuation during the past 4 years. In FY 2001, it reported directly to the Commissioner, W&I Division. In July 2002, the EITC Office was moved to report to the Director, Strategy and Finance, W&I Division. In October 2003, it was placed back directly under the Commissioner, W&I Division. At that time, the IRS appointed an executive to direct the EITC Office, which is responsible for managing the EITC Program.
While we believe creating an executive-level position benefits the coordination and oversight of the EITC Office and related Program, that executive still faces the difficulty of holding accountable the functions that complete EITC Program work. Most of these functions do not report to the EITC Office. For example, the Stakeholder Partnerships, Education, and Communication function is responsible for education and outreach. The Field Assistance function is responsible for assistance with the preparation of tax returns claiming the EITC and resolution of issues related to EITC notices. Both of these functions report to the Customer Assistance, Relationships, and Education function. To address this, the EITC Office developed a mechanism that tied compliance and other functions to the W&I Division Strategic Plan.
A Service Level Management process was established to provide a framework for documenting, monitoring, and evaluating the levels of service provided to the EITC Program by the various organizations within the IRS. Essential to this process are Service Level Agreements (SLA), which are negotiated with each function involved in the administration of the EITC Program. The SLAs document and formalize the services being provided by the operating and functional divisions, as well as the support the EITC Office will provide to the respective divisions. The EITC Office plans to establish with major functions SLAs that tie their EITC Program responsibilities to the EITC Strategic Plan.
At the time of our review, the EITC Office had finalized the
We believe the
To ensure the
1.
Closely
analyze the results of the
Management’s Response: IRS management agreed with this
recommendation. The EITC Office will
monitor and analyze the results of the
The IRS faces many challenges in administering the EITC Program, including the complexity of the tax law and the changing emphasis on the EITC Program by both Congress and the GAO.
Tax law complexity
The EITC Program eligibility rules are difficult and complicated for both taxpayers and the IRS. The complexity causes taxpayers and IRS employees to make errors while attempting to interpret and apply the tax laws to their individual situations. An analysis performed by the National Taxpayer Advocate (NTA) shows that many low-income taxpayers struggle to determine EITC Program eligibility. Some taxpayers lack understanding of the eligibility issues related to family status, such as the dependency exemption and head of household filing status.
The IRS has several initiatives underway to educate taxpayers and their representatives about EITC Program eligibility, and the NTA is attempting to address many of the issues through administrative and legislative recommendations. The Working Families Tax Relief Act of 2004 made changes to family status definitions that may reduce the complexity of the determinations.
Changing emphasis
on the EITC Program
The level of emphasis on the EITC Program is shifting toward other areas of tax law enforcement. Recently, both the GAO and Congress combined EITC Program concerns with the broader area of tax law enforcement.
In 2001, the GAO named EITC Noncompliance as a high-risk area because of the particularly high incidence of fraud and other forms of noncompliance. The GAO 2005 high-risk status report combined the EITC Noncompliance and the Collection of Unpaid Taxes high-risk areas into a single area – Enforcement of Tax Laws. The GAO believes the focus of concern on tax law enforcement is not confined to any one segment of the taxpaying population or any single tax provision.
Congress dedicated a specific appropriation for EITC Program compliance initiatives (both to curb noncompliance and encourage participation) in FYs 1998 through 2003. However, in the FY 2004 budget, Congress returned to appropriating a single amount for the IRS to allocate among its various tax law enforcement efforts.
Merging the EITC Program funds into the TLE account allows the Commissioner, W&I Division, to maneuver dollars between programs. However, combining the funds made it more difficult for the EITC Office to track its funds. After the EITC Program funds were merged into the TLE account, the EITC Office had no way to monitor its fund separately, and special reports were developed by the Chief Financial Officer to allow the EITC Office to monitor funds more easily. The EITC Office relies on these reports to show the money budgeted and spent by the individual functions.
With both the GAO and Congress changing their emphasis on the EITC Program, the EITC Office should be prepared to face the possibility that it may have to operate with fewer funds yet still continue to produce a valuable product. Fewer funds could affect the future of the EITC Program because the result would likely be fewer outreach and education activities and fewer compliance initiatives. Since the Commissioner, W&I Division, has the flexibility to maneuver dollars between programs, funds may be redirected from the EITC Program to other TLE programs.
Appendix I
Detailed
Objective, Scope, and Methodology
The objective of this review was to assess the Internal Revenue Service’s (IRS) progress in improving the administration of the Earned Income Tax Credit (EITC) Program since Fiscal Year (FY) 2002. This was a follow-up audit to a report we issued in June 2003, in which we reported that long-term performance goals and measures were needed and fragmented management reduced the effectiveness of efforts to improve administration of the EITC Program. We evaluated the IRS’ progress in administering the EITC Program between October 1, 2002, and September 30, 2004.
Our testing was limited to reviewing IRS management reports in FYs 2003 and 2004 and discussing the EITC Program with appropriate officials. We did not conduct testing to verify the accuracy of the reports, nor did we do any tests to validate the data reported by the IRS. To accomplish our objective, we:
I. Determined the organizational structure, status, goals, and strategies for the EITC Program as of September 30, 2002. We reviewed our June 2003 audit report and the IRS’ FY 2002 business plans and reports to determine the status of the EITC Program at the end of FY 2002.
II. Determined the changes and progress the IRS has made in the administration of the EITC Program.
A. Identified the projects, programs, and initiatives the IRS implemented during FYs 2003 and 2004 in an effort to increase the number of eligible taxpayers who claim the EITC (EITC Program participation rate). We determined the impact of the Proof of Concept Tests by researching the IRS’ FYs 2003 and 2004 strategic plans and meeting with appropriate IRS officials in the EITC Office.
B. Identified Government Accountability Office concerns with the IRS’ ability or efforts to improve participation in the EITC Program and reduce and prevent EITC overclaims. We determined which corrective actions the IRS indicated would be completed prior to the end of FY 2004.
C. Evaluated the IRS’ activities during FYs 2003 and 2004 to determine its progress in increasing participation in the EITC Program and reducing EITC overclaims by comparing FYs’ 2003 and 2004 performance results to the results as of the end of FY 2002.
III. Evaluated the IRS’ ability to significantly improve administration of the EITC Program as a result of changes made in the EITC Office and to the Program itself. We determined whether the Program changes addressed the recommendations made in our June 2003 report.
A. Determined how effectively the EITC Program funds were being tracked after they were merged with the Tax Law Enforcement account.
B. Determined whether the structure of the EITC Office allows adequate oversight of the employees working EITC Program cases by reviewing the concept of the Service Level Agreements.
C. Determined how the EITC Office keeps abreast of legislative changes and how it incorporates legislative changes into planning.
D. Determined what the IRS did to prepare for or address changes in the economy or taxpayer base that could affect EITC Program participation. We interviewed EITC Office personnel to determine what they use to forecast the EITC Program population and how this is incorporated into the strategic planning process.
E. Determined how the EITC Office communicates with Congress and outside stakeholders to gather stakeholder opinions.
F. Reviewed the Wage and Investment Division Strategic Plan to determine whether the IRS had established long-term goals and related measures for the EITC Office that reflect anticipated outcomes. We determined whether the IRS had established a consistent method to measure progress toward its long-term goals and whether the method includes an assessment of the frequency with which the measures are computed.
Appendix II
Major Contributors to This
Report
Michael R. Phillips, Assistant Inspector General for Audit (Wage and Investment
Income Programs)
Scott A. Macfarlane, Director
Deann L. Baiza, Audit
Manager
Sharla J. Robinson,
Acting Audit Manager
Kathleen A. Hughes,
Senior Auditor
Tracy K. Harper,
Auditor
Sandra L. Hinton,
Auditor
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, Earned Income Tax Credit SE:W:EITC
Acting Director, Strategy and Finance, Wage and Investment Division SE:W:S
Acting Chief, Performance Improvement, Wage and Investment Division SE:W:S:PI
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 Liaisons:
Director, Communications and Liaison
TA:CCL
Acting Senior Operations Advisor, Wage and Investment Division SE:W:S
Appendix IV
Earned Income Tax Credit Program
Rules
Below is a general description of the qualifications taxpayers must meet to be eligible for the Earned Income Tax Credit (EITC). A detailed description of these rules can be found in Internal Revenue Service publication Earned Income Credit (EIC) (Publication 596).
Everyone must meet all of the
following rules:
· Your investment income must be $2,650 or less.
· You must have earned income.
Rules to meet if you have a
qualifying child (must meet all):
· Your child must meet the relationship, age, and residency tests.
· You cannot be a qualifying child of another person.
Rules to meet if you do not
have a qualifying child (must meet all):
·
You must have lived in the
Appendix V
Earned Income Tax Credit Program Organization
Chart
The shaded functions in the organization chart below are responsible for various aspects of the Earned Income Tax Credit Program.
The chart was removed due to its size.
To see the chart, please go to the Adobe PDF version of the report on
the TIGTA Public Web Page.
Appendix VI
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.