The pressure on the IRS to deliver the economic impact payment (EIP) highlights some of the general challenges the IRS faces when Congress tasks the IRS to deliver benefits. With respect to the EIP, faced with a public that needs the money that Congress has earmarked, IRS has had to move quickly. In times like these, when balancing speed with accuracy, IRS should and admirably has erred on the side of speed. With lives upended and millions of Americans struggling, this is the right call.
As an administrator that regularly gets taken to task when it comes to its administration of refundable credits like the EITC, IRS faces a similar trade off in its more routine day to day work. IRS knows that millions of Americans rely on those Code-based benefits. At the same time, about 25% of the EITC is classified as an improper payment, as Congress has been sure to remind Commissioner Rettig when he has been up on the Hill.
Two recent publications highlight the competing pressures the IRS faces as a result of it having responsibility for administering the EITC. One is a TIGTA report taking the IRS to task for failing to impose civil penalties and bans on individuals who appear to be improperly claiming the EITC. The other is a Treasury Office of Tax Analysis (OTA) working paper that emphasizes that the vast majority of people claiming the EITC have an eligible familial relationship with a claimed qualifying child.
For folks who are looking for differing perspectives on an issue I suggest that you read both, back to back. If reading TIGTA reports and OTA working papers is not your ideal way of spending an afternoon, in this post I will discuss the highlights of both.
TIGTA: IRS Not Doing Enough to Deter and Punish Improper Claimants
First, the TIGTA Report. TIGTA’s steady drumbeat on EITC and refundable credits is that IRS is not using the enforcement tools that Congress has given to it.
Congress provided the IRS with tools to address taxpayers identified as submitting fraudulent or reckless refundable credit claims. These tools include the authority to assess the erroneous refund penalty and require taxpayers to recertify that they meet refundable credit eligibility requirements for credits claimed on a return filed subsequent to disallowance of a credit, and the ability to apply two-year or 10-year bans on taxpayers who disregard credit eligibility rules. However, the IRS does not use these tools to the extent possible to address erroneous credit payments.
What are the consequences of IRS not using its robust power to sanction taxpayers? In TIGTA’s view,
[t]he ineffective use of the various authorities provided in the I.R.C. is a contributing factor in the high rate of improper payments. The IRS estimates that 25 percent ($18.4 billion) of EITC payments made in Fiscal Year 2018 were improper payments. The IRS also estimates that nearly 33 percent ($8.7 billion) of ACTC payments made during Tax Years 2009 through 2011, and more than 31 percent ($5.3 billion) of AOTC payments made during Tax Year 2012, were potentially improper.
The main gripe TIGTA emphasizes is that the IRS has failed to use its power to impose a 20% erroneous refund penalty under Section 6676, a power that Congress amended a few years ago to specifically apply to individuals erroneously claiming refundable credits like the EITC:
In Years 2015, 2016, and 2017, the IRS assessed the erroneous refund penalty on 3,190 erroneous claims totaling $2.7 million. However, our analysis identified 494,555 withholding and refundable credits disallowed for Tax Years 2015, 2016, and 2017 (as of December 27, 2018). These taxpayers filed 798,504 tax returns that claimed more than $2.6 billion in improper withholding or refundable credits. Applying the 20 percent erroneous penalty rate to the disallowed credits computes to almost $534.7 million in penalties that the IRS potentially could have assessed.
TIGTA goes on state that IRS has studied the impact of the few cases when IRS has in fact imposed the 6676 penalty, and it appears that IRS is teeing up some recommendations based upon its study (FYI – I have not seen the study nor do I know if IRS is planning on releasing it; it would be interesting as well to see how much tax is collected out of previously assessed penalties—I suspect not much).
The report also criticizes IRS for failing to systematically impose a two-year ban on taxpayers who in TIGTA’s view are recklessly or intentionally disregarding rules and faulty IRS processes for allowing individuals to recertify eligibility for the EITC (and other disallowed credits). As to the ban, TIGTA notes that in successive years people appear to be incorrectly claiming the EITC. ( Note: as advocates know appearances may be misleading as claimants may be unaware of the rules or simply not able to document meeting eligibility criteria. For more on the ban, see Bob Probasco’s excellent three part series, The EITC Ban-Further Thoughts Part 1, Part 2 and Part 3.) In a heavily redacted section, TIGTA suggests that the IRS should impose the ban earlier and more frequently. This would free scarce audit resources to investigate other individuals and prevent erroneous claims.
The TIGTA report also discusses recertification. For individuals who have had credits denied through deficiency procedures, Section 32(k) provides that “no credit shall be allowed under this section for any subsequent taxable year unless the taxpayer provides such information as the Secretary may require to demonstrate eligibility for such credit.” TIGTA highlights IRS problems with its processes to ensure that taxpayers who recertify are in fact eligible for the claimed credits.
OTA: The “Improper” EITC Claimants Look Like the Proper Claimants
The OTA paper looks at the EITC very a different perspective. While noting the stubborn 25% or so improper payment rate, OTA attempts to study the characteristics of the people who are not eligible or who appear to be overclaiming the credit. The reason for the inquiry is to help frame the debate around improper payment rates. As OTA notes,
from the social welfare perspective, policymakers might view a case where a child lived with her low-income grandmother for 6 months of the year differently from a case where an unrelated person claimed a child she did not live with at all; but, both cases would be counted equally in computing the EITC error rate.
What the improper payment rates alone fail to tell us is context.
When a taxpayer fails to meet the qualifying child tests for an EITC claim, it is generally unknown how closely this taxpayer is related to the child and whether another taxpayer could have correctly claimed the child.
It is possible for more than one taxpayer to have provided some care for the child during the year, but no single taxpayer to be eligible to claim the EITC for that child under the law (e.g., the child does not live with any taxpayer for more than half the year). In other cases, the erroneous claim may have precluded the actual caregiver from claiming the child.
What OTA does in the paper is to provide more detail to allow for a “more nuanced consideration of EITC qualifying child errors and the associated social welfare implications.”
What kind of nuance did OTA look to identify? Essentially OTA looked to see if there was a family relationship between the adult and the child claimed as a qualifying child:
Specifically, we analyzed the intensity of the familial relationship between the child and the actual claimant as well as the length of the shared residency, providing information about whether the claim, despite being erroneous, might nonetheless have supported a low-income worker caring for a child. In addition, we studied possible reasons why the “wrong” taxpayer may have claimed the child—whether this occurred due to complicated family circumstances, intentional credit-maximizing behavior, or other reasons—to better understand the causes of EITC noncompliance. Finally, we estimated the credit that could have been received by the parent who did not already claim the child and was potentially the actual caregiver. This result offers an insight into the extent to which the EITC improper payment estimates may overstate not only the social welfare loss but also the monetary loss to the government.
OTA’s study showed that in the overwhelming number of cases, when there was an error, there still was a close familial relationship between the adult and the child or children, though typically the adult was not the child’s biological parent:
Our analysis suggests an intense relationship between the child and the claiming taxpayer in most cases. About 87 percent of the children, despite being claimed with qualifying child errors, had a valid familial relationship (84 percent) or lived with the taxpayer for more than half of the year (7 percent) or both. However, compared to children who met all of the qualifying child tests, the children in our sample were much less likely to be the son or daughter of the taxpayer, and more likely to have other valid familial relationships (e.g., grandchild or nephew/niece) with the taxpayer.
The whole paper deserves a careful read, but the bottom line conclusion is that the majority of children claimed with qualifying child errors had an eligible familial relationship with their claimants and in a majority of the cases there was no parent who under current eligibility criteria could in fact be eligible to claim a child.
Furthermore, about 60 percent of the children did not appear to have a parent who could be the “right” taxpayer, as stipulated by law, who could file a claim. We conclude that a substantial portion of erroneous EITC claims likely helped support children in low-income families despite those children being claimed in error. Parents of another 4 percent of children were found to have filed a duplicate claim with the taxpayer under audit. For the remaining 36 percent of children, who had a tax-filing parent not already claiming the child, the family members’ filing patterns were consistent with the credit-maximizing motive in 85 percent of cases. We offer a few explanations, including taxpayer confusion about EITC rules or law changes, to account for the claiming pattern of the remaining 15 percent of cases. Finally, we estimate that the forgone credit that could have been received by non-claiming parents amounted to about 10 percent of the total overclaims attributable to qualifying child errors, or 4 percent of all EITC overclaims. Taken together, these results suggest that the official improper payment rate overstates the social welfare loss and monetary loss to the government. (emphasis added)
At the end of the day, the OTA study and TIGTA report are likely to appeal to differing parts of the trade off I discussed in the introduction. It could very well be that administrators (and readers and Congress for that matter) do not necessarily value social welfare concerns in the same way that I or others do. People could place a higher value on rule following. After all, Congress is responsible for determining the eligibility criteria, and it could change the criteria to reach some of the adults who are improperly claiming the credit (I and others have suggested this in past papers, most recently from me in the special report to Congress on the EITC that was part of the TAS FY 2020 Objectives Report).
How does the current pandemic and economic crisis influence this issue? If I were in the IRS now, I would be strongly advocating for the IRS to slow down on the TIGTA recommendation to impose more civil penalties and sanctions on EITC claimants. Context matters. People are struggling. While it should not mean a green light for allowing erroneous claims to go out of the door, OTA helps us understand that the overwhelming majority of Americans who appear to be improperly claiming the credit have a close family relationship with the children identified on their tax return.
When the current crisis clears, Congress should take a hard look at the EITC and other credits. It could help the IRS by boosting the childless EITC, which in addition to helping millions of working Americans will also likely decrease incentives for people to share children to ensure eligibility. Congress should also reconsider the eligibility requirements that are difficult and expensive for the IRS to verify and which make less sense in today’s world, like pegging eligibility on arbitrary residency rules that 1) may understate the importance of family members who are connected financially and emotionally but who do not live with a child for more than 6 months and 2) do not work well when there are multigenerational families living together.