Treasury Inspector General for Tax Administration
September 23, 2015
TIGTA - 2015-30
Contact: David Barnes
WASHINGTON -- The Internal Revenue Service (IRS) does not have sufficient controls and processes in place to identify erroneous Foreign Tax Credit claims, according to a report publicly released today by the Treasury Inspector General for Tax Administration (TIGTA).
The United States generally taxes U.S. citizens and resident aliens on their worldwide income, and foreign persons on their U.S. source income. The Foreign Tax Credit is intended to reduce the double taxation burden that would otherwise occur when foreign source income is taxed by both the United States and the foreign country from which the income is derived. The Foreign Tax Credit can significantly affect the amount of taxes paid by individuals on U.S. tax returns. In Tax Year 2013, taxpayers claimed more than $16.7 billion in Foreign Tax Credits.
Due to the Foreign Tax Credit’s complexity and a lack of third-party reporting information, there is a risk of some taxpayers claiming an incorrect Foreign Tax Credit amount. This audit was initiated to determine whether IRS controls ensure that the Foreign Tax Credit is accurately claimed on a tax return when foreign government taxes are used to offset Federal taxes.
TIGTA’s analysis of paper and electronically filed individual tax returns for Tax Years 2010 through 2012 identified that the IRS allowed $94.9 million in potentially improper Foreign Tax Credits on 65,499 tax returns and allowed taxpayers to file 16,058 tax returns that claimed nearly $2.9 million in Foreign Tax Credits as a deduction, as well as a credit on the same foreign taxes paid. The IRS also allowed nearly $40 million in potentially erroneous Foreign Tax Credits on 188,102 tax returns when third-party information return documents did not support the Foreign Tax Credits claimed, and incorrectly transcribed the Foreign Tax Credit on 4,806 taxpayer accounts.
Further analysis of those tax returns with improperly allowed Foreign Tax Credits determined that 197,263 (73 percent) were prepared by paid tax preparers, with exceptions totaling approximately $98.2 million. In addition, the IRS did not refer 1,161 examination cases that potentially met mandatory Foreign Tax Credit referral criteria to international examination specialists. The IRS also does not monitor or track assessments made on Foreign Tax Credit cases.
“The IRS should always make sure that compliance checks exist when taxpayers fail to take the required steps in order to claim a credit, and this is especially important for potentially large credits like the Foreign Tax Credit,” said J. Russell George, Treasury Inspector General for Tax Administration.
TIGTA recommended that the IRS: 1) establish controls to ensure that the Form 1116, Foreign Tax Credit, is attached when required; 2) ensure that any training materials and additional guidance related to Foreign Tax Credits are updated, and that employees comply with the updated guidance; 3) develop a compliance strategy to address the risks identified with taxpayer Foreign Tax Credit issues; 4) capture and maintain key Foreign Tax Credit statistics; 5) improve education, outreach, and enforcement activities to correct the paid preparer issues related to the Foreign Tax Credit; and 6) revise the Internal Revenue Manual and the Specialist Referral System User Guide to clearly define the referral criteria that will be followed to ensure that tax returns in the examination function inventory with Foreign Tax Credits are referred as required.
IRS officials agreed with five of TIGTA’s recommendations and have taken or plan to take corrective actions. In addition, the IRS partially agreed with the remaining recommendation to identify and track key Foreign Tax Credit statistics. The IRS has implemented a system to assist in identifying potential noncompliance and trends involving international issues, including the Foreign Tax Credit. However, further enhancements to gather statistics are not possible due to current budget and resource restrictions.
Read the report.
Note: The difference between the date TIGTA issues an audit report to the Internal Revenue Service and the date TIGTA publicly releases the report is due to TIGTA's internal review process to ensure that public release is in compliance with Federal confidentiality laws.
A special plugin is required to view PDF documents. To obtain the free PDF reader, please visit the Adobe web site.