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.