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the earned income tax credit is considered one of the most efficient federal programs for sustaining people with inadequate income. part of the eitc’s efficiency results from the lack of an intermediary checking the qualifications of those who receive it.
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the tax return itself is the application for eitc. there is no other process, no pre-return vetting, no social workers. the closest thing to an intermediary is the tax preparer who makes sure the correct income is reported and the correct forms filled out.
the efficiency inevitably leads to errors. efficiency always does. but in the case of the eitc, the error rate is uncomfortably high.
actually, the error rate is high in two different uncomfortable ways.
way one:
the irs estimates that in 2018, just over 25 percent of eitc credits were improper payments – about $18.4 billion out of total eitc payments of $73.6 billion. (the estimate for 2018 is extrapolated from audits conducted on 2014 returns.) the improper payments are the results of anything from malfeasance to bad math to taxpayer confusion.
way two:
not everyone who qualifies for eitc actually receives it. for every dollar of improper payment, there were 40 cents of unclaimed credits.
the irs is required to categorize the causes of improper payments and failure to claim the entitlement. ninety-four percent of failures to claim are categorized as “inability to authenticate eligibility: data needed does not exist.” in half of those cases, it is a “qualifying child” who is claimed but cannot be properly documented. a quarter of the cases were taxpayers who correctly reported income and other information, but that information did not match erroneous information provided to the irs by third parties, usually employers.
the culprit: not fraud but complexity
unfortunately, the categorized causes of improper payment did not include a likely culprit – the complexity of rules and consequent errors. experience elsewhere in the irs shows that simplified rules can reduce noncompliance.
part of the problem may be inherent to the program. by definition, the people who qualify for eitc are in the lowest income brackets. they have little disposable income, and they may be reluctant to spend it on a tax preparer. if they do make that investment, they are more likely to go to a low-cost, bargain-basement, fly-by-night preparer who is more concerned with his or her own income than that of the taxpayer.
and of course those lower-income taxpayers who try to do their own taxes are more likely to
- not understand english especially well,
- not understand finance and tax preparation especially well,
- not know about eitc,
- not know how to file for eitc,
- not understand what documentation is acceptable and
- make errors in calculations.
tax practitioners as intermediaries
in that competent, responsible tax practitioners are able to resolve all those problems, they could be be the intermediaries that the irs needs to reduce the cases of improper payments and unclaimed credits. given the complexity of the return and the requisite documentation, applying for eitc is a job for a professional, not the poor.
in some cases, a single eitc payment qualifies as both of the aforementioned way one and way two: somebody receives an improper payment, preventing someone else from receiving a proper payment.
these double-whammy cases typically involve a child who is entitled to the benefit, most likely because of parents not living together. one parent claims and improperly receives the eitc … but that’s not the parent with the child. because of that improper claim, the parent with the child does not receive the credit that the child is entitled to.
correctible error authority
the taxpayer advocacy service says that irs seems to be trying to solve the problem more by enforcing infractions than by facilitating the input of taxpayer information. one aspect of that enforcement is “correctible error authority” – the irs’s power to proactively correct the numbers on a return to match the numbers that the irs has from other sources. in that a quarter of the irs’s information is incorrect, the irs is unjustifiably burdening a large number of taxpayers with an added level of difficulty in paying no more than what they owe and receiving whatever they might be due.
the irs also has the authority to impose a two-year ban on claiming eitc if a claimant is determined to have acted with “reckless or intentional disregard of rules and regulations.” while that seems fair and reasonable in the case of actual cheaters, it turns out the irs imposed the ban improperly 49 percent of the time in 2009, 44 percent in 2010, and 39 percent in 2011. in 2017, 3,442 taxpayers were banned.
in its annual report to congress, the tas says that the irs is making too little effort to deal with perceived taxpayer error. current practice is to send a “soft” letter to taxpayers who seems to have claimed eitc in error. without getting specific, the letter asks them to check their returns to verify the information.
the irs studied the effectiveness of the soft letters. they were found to have minimal effect on taxpayer behavior.
a little experiment
so the tas did a little experiment. they sent out “salient” letters to a representative sample of taxpayers with eitc problems. the letters were sent during tax season in the belief that they were more likely to be opened. rather than the soft, generic message the irs sends out, the salient letter was tailored to identify the specific error that seemed to be the problem. the letter also offered a dedicated “extra help” telephone line.
only 35 of the 967 contacted sampling called the extra help line, but extrapolated out for all taxpayers with eitc problems, $44 million in erroneous eitc claims could have been averted.
the irs plans to send out more “soft” letters this year despite the tas’s urging that the letters offer a dedicated help line and more specificity about the problems that have to be addressed.
the gross tax gap
eitc payments make a substantive difference to poor families, but the amount of improper payments to claimants is a minuscule part of the “tax gap.”
the gross tax gap is the total tax liability that taxpayers owe but do not pay. the most recent estimate of the tax gap is $458 billion. a large portion of the gross tax gap – 58 percent, or $264 billion – is attributable to misreporting by individual taxpayers. the three largest components are:
- $125 billion (47 percent) attributable to misreporting of business income
- $64 billion (24 percent) attributable to misreporting of non-business income
- $40 billion (15 percent) attributable to misreporting of credits
the tas says that of the $40 billion in misreported credits, $26 billion is attributable to eitc misreporting. in other words, 6 percent of the gross tax gap is attributable to improper eitc payments.
much of that 6 percent – the tas did not say how much – is because of innocent error resulting from complex rules or taxpayer incompetency. had competent professional tax practitioners calculated the returns, the portion of the gross tax gap would probably be much lower.
recommendations
the tas report to congress made several recommendations that could minimize improper payments while maximizing receipt of entitled payments. among the recommendations are:
- the irs should collaborate with the tas to devise methods of identifying taxpayers who are entitled to eitc.
- the irs should conduct a study of how many taxpayers could use affidavits to meet residency requirements.
- the irs should revise notices sent to questionable eitc claimants to include specific explanations of perceived problems.
- the irs should have a year-round toll-free help line dedicated to eitc and child tax credit questions.
unfortunately, the tas did not mention the role that tax practitioners could play in reducing the problems. such a suggestion would be outside the scope of the tas. but that doesn’t mean tax practitioners are outside the scope of possible solutions. maybe they could be the intermediaries who make the eitc more fair and efficient.