Refundable credits, unlike
other tax credits, not only have the potential to reduce a taxpayer’s tax
liability to zero, but also allow the taxpayer to receive a cash payment of any
remaining credit amount. This makes refundable tax credits more susceptible to
fraud. Without proper controls, billions of taxpayer dollars are vulnerable to
erroneous claims and fraudulent tax schemes.
An audit was completed
this year by the Treasury Inspector General for Tax Administration (TIGTA) to
look into just how vulnerable tax credits such as the Earned Income Tax Credit
and Additional Child Tax Credit are to fraud. The audit also looked into how
effective the IRS’s efforts have been to recover erroneous tax credits.
The TIGTA found that
during tax years 2006 through 2009, taxpayers claimed almost $470 billion in
refundable credits. Due to post-refund examinations, taxpayers were required to
repay more than an estimated $2.3 billion in erroneous credits. By the end of
December 2011, the IRS had recovered an estimated $1.3 billion, of which more than
70 percent was collected through refund offsets.
Furthermore, the audit
found that taxpayers repeatedly claimed incorrect Additional Child Tax Credits
after being disallowed the previous year. The IRS could have saved more than
$108 million by reviewing claims made by taxpayers who were previously
disallowed this credit.
“Because of the
susceptibility of these credits to fraud, and the low success rates in
recovering erroneous credits once refunds have been issued, the IRS should take
every reasonable step possible to identify potentially questionable credits and
validate those credits before associated refunds are issued,” said TIGTA
Inspector General J. Russell George in a summary of the audit.
To collect improper
refundable credits issued to taxpayers, the IRS often relies on a process of
refund offsets, which withhold future tax refunds to repay any amounts owed to
the IRS. If a taxpayer does not repay the amount owed in a timely manner, the
IRS must wait for the annual tax season to collect any money— and would only be
able to collect it the taxpayer was eligible for a refund.
TIGTA recommended that
the IRS implement additional controls to identify and stop erroneous claims for
refundable credits before refunds are issued, including:
- Implementing an account indicator to identify taxpayers who claim erroneous refundable credits. Taxpayers with such an indicator should be required to provide documentation before their claims for refundable credits are processed and should be considered for pre-refund examinations of claims for all refundable credits. Such an indicator should be applied for a specified time period.
- Freezing and verifying claims for the Additional Child Tax Credit (ACTC) on all returns for which the Earned Income Tax Credit (EITC) is frozen.
- Working with the Department of the Treasury’s Office of Tax Policy to seek legislation to expand the EITC due diligence requirements to include the ACTC.
IRS management agreed
with TIGTA’s recommendations and plans to take appropriate corrective actions.
Rather than implementing an account indicator to identify taxpayers who claim
erroneous refundable credits, the IRS plans to develop pre-refund examination
filters to ensure historical information is available and used as selection
criteria. Although this planned action is different than what TIGTA
recommended, TIGTA believes that it is a viable alternative.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.
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