IRS is paying tens of billions of fraudulent refundable tax credits

On May 25, 2011, J. Russell George, the Treasury Inspector General for Tax Administration (TIGTA) testified before the House Ways And Means Subcommittee on Oversight. In comments entitled “Improper Payments in the Administration of Refundable Tax Credits”, George described significant fraud that the IRS is allowing to occur, supposedly because it does not have the resources to address this known issue. Tens of billions of dollars could be saved by simply enforcing laws as they are written.

Unless active checking of refund credits occurs, refundable credits are a predictable disaster waiting to happen. The TIGTA described the situation as follows:

…The unintended consequence of these credits is that they are often the targets of unscrupulous individuals who file erroneous claims for these credits. In its June 14, 2010, report to TIGTA, the IRS noted that they have found that refundable credits of significant amounts attract fraud. … Nonrefundable tax credits are limited to the amount of an individual’s income tax liability. As such, the maximum benefit an individual will receive if a nonrefundable credit is claimed inappropriately is to fully offset his or her tax liability resulting in owing nothing. Refundable credits do not have such limitations. In essence, individuals can obtain money that they did not earn and to which they are not entitled simply by claiming a refundable tax credit. Refundable credits can result in tax refunds even if no income tax is withheld or paid; that is, the credits can exceed the liability for the tax.”

The fraudulent conduct is enormous. Absent addressing the problem in a meaningful additional way, the fraud raises issues about the appropriateness of the entire program. According to the TIGTA’s testimony:

The total amount of improper payments relating to refundable credits far exceeds the amount of fraudulent tax refunds the IRS identifies and stops …

Earned Income Tax Credit – The IRS continues to report that 23 to 28 percent of EITC payments are issued improperly each year. In Fiscal Year 2009, this equated to $11 to $13 billion in improper EITC payments. Although the IRS has annually reported billions in EITC improper payments since it began reporting estimates to Congress in 2002, little improvement has been made in reducing these payments.”

This is hardly a new problem, but the Administration is unable or unwilling to do what is necessary. Again, in the words of the TIGTA:

…the IRS did not include required strategies or quantifiable targets to reduce EITC improper payments. IRS management noted that reduction targets were not set because it has to balance compliance and enforcement resources among all income groups.

We have conducted a number of audits that have identified opportunities to reduce EITC improper payments. We have provided the IRS with specific actions that could be taken to reduce improper payments and allow the IRS to establish measurable reduction targets. While the IRS has implemented some of our recommendations, it has not taken action to address key recommendations aimed at preventing or reducing improper EITC payments. For example, we reported in December 2008 that the IRS had developed processes to successfully identify billions of dollars in erroneous EITC payments. However, the IRS stated it did not have the resources to implement the processes that would help address many of these cases, resulting in the majority of the improper claims being paid.”

During the same hearing, the Government Accountability Office (GAO)  presented a report which comments on the IRS’s apparent lack of authority to even check for some of these problems. This notion seems ridiculous, but the GAO says its true, as follows:

Prerefund compliance checks enable IRS to help confirm taxpayers’ identity, quickly and efficiently correct some errors with virtual certainty, and identify and audit some returns before refunds are issued. Math error checks are among the most beneficial of these checks for both IRS and taxpayers. For example, they have the potential to deter billions of dollars in erroneous refunds, especially for refundable tax credits that have increasingly been enacted and that have resulted in significant overclaimed refunds and fraudulent claims. …

In 2010, GAO suggested that authorizing the use of MEA (math error authority) on a broader basis with appropriate controls to protect taxpayer rights could help IRS immediately address compliance problems with newly created tax credits.

This describes a similar report involving the refundable credits for first time home purchases. An earlier blog entry describes the wrong-headed approach that is currently being used for tax administration.

This deserves significant additional attention from the current administration.

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