The new non-annual child tax credit payout could face a similar tension as other tax-based social benefit programs between concerns over improper or fraudulent payouts and Congress’s intent to help some taxpayers.
The American Rescue Plan Act of 2021 (P.L. 117-2), which President Biden signed into law March 11, includes a new experiment in delivering social benefits programs through the tax code: For one year, the child tax credit will be paid periodically and in advance.
Like any tax credit and especially refundable ones, the new program will present the unscrupulous with a tempting opportunity for fraud and abuse, Joseph A. Rillotta of Faegre Drinker Biddle & Reath LLP told Tax Notes.
The legislation also raised the amount of the credit to $3,000 or $3,600 for children younger than 6 for 2021.
Don Fort of Kostelanetz & Fink LLP said the question will be whether the IRS builds on the advance payment delivery system with an eye to quickly placing money in the hands of taxpayers who need it or toward ensuring that as little of the money as possible reaches those just looking to take advantage. The widespread financial suffering amid the COVID-19 pandemic creates pressure to send the relief as quickly as possible, but that pressure must be balanced against the risk of fraud in the program, he added.
Fort should know about attempts to cheat COVID relief efforts. As chief of the IRS Criminal Investigation division when Congress passed the Coronavirus Aid, Relief, and Economic Security Act, he oversaw criminal enforcement efforts against those who tried to take illicit advantage of the variety of relief programs in the bill, like the economic impact direct payments, the employee retention tax credit, and the forgivable Paycheck Protection Program loans.
Learning Tolerance
Former National Taxpayer Advocate Nina Olson noted that Congress accounted for some possible improper payments in the advance child tax credit by allowing the IRS to use the information it has as of December 31, 2020. The law also includes a safe harbor for taxpayers under which the government won’t seek to collect overpayments, much like the economic impact payments. In other words, she said, the provision comes with a built-in error tolerance, at least for false positive overpayments.
Of course, oversight bodies like the Treasury Inspector General for Tax Administration and the Government Accountability Office might not consider that ingrained error tolerance when describing improper payments to Congress, according to Olson, now executive director of the Center for Taxpayer Rights.
“If Congress has forgiven it, is it really an improper payment” under the Improper Payments Information Act of 2002? Olson asked. “It was contemplated that there would be errors, so should it be classified as an improper payment?”
Olson said she could see TIGTA writing improper-payment reports that would become a political issue in the same vein as for the earned income tax credit.
Any problems the IRS, TIGTA, or the GAO find in the few months for which the advance child tax credit payments are made shouldn’t be treated as arguments against the idea, Olson said. Rather, the whole experience should result in a proof of concept and many lessons about what worked and what didn’t, she added, likening 2021 to a field experiment.
Guarding the Gates
Olson and Rillotta both noted the IRS has made heavy use of fraud filters and other technological solutions to rein in the identity theft refund fraud problem.
However, Olson said she would have a problem with the IRS using the same process for the advance child tax credit, mostly because the agency doesn’t make enough use of artificial intelligence technology. The fraud filters are just algorithms that pull returns for manual, human inspection. They don’t involve machine learning with which the computers could quickly start to recognize the patterns of proper payments and resolve those cases much more swiftly than manual audits, which can take weeks or months, she explained.
Rillotta, a former Justice Department Tax Division attorney, said that prosecuting fraudsters under the new program will be important, but the government has already correctly concluded in similar situations that prevention is as important as punishment. Answering the IRS’s calls for more funding will improve both the accuracy of its fraud prevention attempts and the quality of its enforcement results, he said.
Fort said that the portal the IRS intends to build for the new program will have to account for a variety of issues that could affect how the unscrupulous and criminally inclined try to take advantage of the system.
Olson said the IRS already uses filters and databases to help verify children’s ages — which will be needed for differences in payout by age — but Fort speculated that anything looser than requiring the taxpayers to supply birth certificates could involve a self-certification system, which attempted fraudsters may exploit.
Unscrupulous tax return preparers, the type to falsify business receipts in a way that maximizes the earned income tax credit, are the most likely to try to criminally exploit the new program, although identity thieves may also try to dip into that pot of money, according to Fort.
Something New
Rillotta said that the new relief program might not be the only part of the new law that will affect tax fraud trends. Other changes like the expanded section 162(m) executive compensation deduction limit could also come into play, he said.
Essentially any change to the parameters of one part of the tax system can affect tax reporting further down the line, according to Rillotta. Changes to the reporting incentives, like when shareholders bear more of the cost of executive raises, can affect behavior as well as attempts to appear to have changed behavior, he said.
So the IRS may have to consider a civil or criminal tax fraud investigation if someone affected by the new executive compensation limit lied to a revenue agent or on a tax return about whether a bit of compensation was a stock option or who the taxpayer worked for, Rillotta said.