TREASURY INSPECTOR GENERAL
FOR TAX ADMINISTRATION
MANAGEMENT ADVISORY REPORT : ADMINISTRATION OF THE EARNED INCOME TAX CREDIT
Reference No. 2000-40-160
Due to continuing concerns about the efficient administration of the Earned Income Credit (EIC), the Treasury Inspector General for Tax Administration (TIGTA) performed a comprehensive assessment of the Internal Revenue Serviceís (IRS) administration of the EIC. The objective of this review was to evaluate the history of the EIC, difficulties the IRS has faced involving the EIC in the past, and the problems the IRS faces in the future.
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 to encourage low-income families to seek employment rather than welfare. This credit provides a major source of assistance to low-income families. The IRS has the responsibility for administering the EIC.
Since the inception of the EIC, laws and the administration of the credit have grown increasingly complex, and the dollars involved have increased significantly. For example, the IRS has gone from the use of a single line on the tax return for the EIC to a publication and schedule devoted to EIC instructions and computations. The amount of the allowable credit has expanded from a maximum amount of $400 in 1975, to $3,816 in 1999. The maximum amount of earned income or Modified Adjusted Gross Income allowed to qualify for the credit has expanded from $8,000 to $30,580 during the same time frame. In addition, the criteria for the credit has been complicated by qualifying EIC child rules, expanded phase-in (credit gradually increases with income) and phase-out (credit gradually decreases with income) levels, and the availability of receipt of advance payments of the credit throughout the tax year (advance EIC).
As the EIC has evolved, many more taxpayers have become eligible for the credit. Along with expansion has come growth in EIC noncompliance, both unintentional and fraudulent. The Congress has also been concerned with the effectiveness of the IRS to both achieve full participation levels in the EIC among taxpayers who qualify for the credit and reduce EIC noncompliance. In 1997, the Congress authorized the IRS to spend a total of $716 million over a 5-year period for the improved administration of the EIC.
Although the EIC program is a highly visible and well-known source of noncompliance, it is not the most significant. In his May 8, 1997, testimony before the House Committee on Ways and Means, the Treasury Deputy Assistant Secretary for Tax Analysis stated that the IRS released a study that the gross individual income tax gap in 1992 was between $93.2 and $95.2 billion. The tax gap was largely attributed to underreporting of business income, underreporting of non-business income, and failure to file tax returns.
The EIC program and its implementation have changed dramatically since it was first enacted. The IRS has faced, and continues to face, problems with a complex processing structure, implementation of legislative changes, and a lack of reliable, current data on compliance and participation levels. As the IRS implements its new organizational structure and works to implement the Government Performance and Results Act of 1993 (GPRA), now is an excellent opportunity to assess the program as a whole and make further improvements.
Earned Income Credit Organizational Structure and Program Administration
The IRS uses a complex process to administer the approximately $30 billion in EIC claims received each year. The over 18 functions that process these claims have conflicting goals and different approaches for achieving full participation and compliance, both between and within functions. For example, one functionís goal is to process paper tax returns and issue refunds within 45 days. Another functionís goal is to identify fraudulent returns during processing of the returns and stop payment of the refunds.
Since Calendar Year (CY) 1993, the Government Accounting Office (GAO), IRS Inspection, and TIGTA have issued numerous reports disclosing widespread and serious weaknesses in the IRSí administration of the EIC. The EIC program has been the subject of extensive review by the GAO, TIGTA, and internal IRS studies. The focus of these studies has centered on two competing problems, EIC full participation and EIC overclaims. Yet, problems with ensuring EIC compliance and full participation still exist. In 1999, the GAO reported EIC fraud as a high-risk area.
Earned Income Credit Research Studies and Initiatives
Studies that addressed the EIC participation rate showed significant differences in the estimates of the percentage of eligible taxpayers that claim the EIC credit. Two studies conducted outside the IRS on EIC participation, released between CYs 1994 and 1998, estimated 70 to 88 percent of eligible taxpayers received the credit. In contrast, another private study conducted from CYs 1996 to 1997 estimated that only 65 percent of the eligible taxpayers nationwide claimed the credit. The IRS is conducting a new study using 1996 tax return information. While the new study will provide the IRS with a more current participation rate, it still will not provide data about todayís EIC population so that a participation rate can be determined.
The EIC noncompliance has been a concern for a number of years. A root cause of EIC noncompliance is that taxpayers determine if they are entitled to receive the credit and the IRS has limited ability to verify entitlement before the refunds are issued. The EIC noncompliance studies conducted on Tax Years (TY) 1994, 1995, and 1997 returns, showed EIC overclaims remained high. The studies showed EIC overclaim amounts reached as high as $9.3 billion, of the total returns with EIC claims for TY 1997, based on preliminary results. The EIC noncompliance studies have remained the only information the IRS has available to baseline EIC overclaims. However, none of these studies have been used by the IRS to establish baselines. Without studies that establish valid and reliable baselines, IRS management cannot accurately identify the population of all eligible EIC taxpayers, measure the extent of noncompliance, or determine if planned activities will achieve desired outcomes.
The IRS has several EIC initiatives underway that include: (1) developing a new taxpayer compliance measure, (2) providing expanded customer service, (3) strengthening enforcement activities, and (4) enhancing research efforts. These efforts are intended to reduce overclaims and erroneous filings associated with the EIC. The IRS received from the Congress $144 million in Fiscal Year (FY) 2000 and will receive another $145 million in FY 2001 to fund these activities. Furthermore, the IRS is reorganizing, which will provide a great opportunity for the IRS to address the ongoing problems of improving compliance and identifying EIC-eligible taxpayers that do not claim the credit. However, plans for the new IRS structure do not improve the way IRS processes EIC returns.
Management Response: For this management advisory report, the primary purpose of the IRSí response was to present an overview of the current status of the EIC compliance program. According to managementís response, the IRS will soon release to the public the most recent EIC study: Compliance Estimates for Earned Income Tax Credit Claimed on 1997 Tax Returns. This study will provide a starting point from which the IRS will be able to evaluate future IRS efforts.
The response also states that the IRS has recently launched new enforcement efforts to detect and prevent erroneous EIC claims before tax refunds are paid. The IRS has also implemented a program aimed at educating paid preparers, and is continuing other outreach programs to state and local governments, faith-based organizations, community groups, business leaders, and low-income taxpayer advocates.
The full response is included in the report as Appendix XIV. Also, an attachment with specific comments is included in managementís response and these comments have been considered for inclusion in the report where appropriate.
Our office plans to complete future work that will assess the progress the IRSí initiatives are making toward improving the administration of the EIC.