The IRS doesn’t like to talk about improper payments which it allows from the U.S. Treasury. There are two kinds of such improper payments. First, there are fraudulent refunds paid out. Treasury Inspector General for Tax Administration (“TIGTA”) J. Russell George reported that the IRS paid $5.2 billion in fraudulent refunds on 1,492,215 tax returns in the year ended September 30, 2010, and that the IRS paid $5 billion in fraudulent refunds in the 2013 filing season.
Identity theft is the prime driver or fraudulent tax refunds. A fraudulent claimant files a false income tax return using the identity of a living or deceased taxpayer, but the claimant’s address. The tax return claims the taxpayer’s refund, which in many cases the IRS pays. If the taxpayer files a true income tax return, the IRS informs him that an income tax return has already been filed using his identity, and that his refund has already been paid. After a lengthy investigation, the IRS will have to pay the refund a second time, to the taxpayer entitled to it. The government is defrauded out of the tax refund falsely claimed from it, and the taxpayer is greatly inconvenienced.
If the IRS receives a refund-claiming tax return from a taxpayer who has a new address, or who does not have a Form W-2, and does not seem to know how much tax was withheld from the taxpayer’s wages during the tax year, the IRS should investigate, including contacting the taxpayer, before paying the refund.
Refundable credits are another cause of improper payments. Refundable credits are treated on tax returns as payments of tax to the government—the IRS pays them out the taxpayer claiming them to the extent they exceed the taxpayer’s tax liability. There are three such credits. The Earned Income Tax Credit (“EITC”) provides assistance to low income taxpayers. The Additional Child Tax Credit (“ACTC”) provides assistance to families caring for refugee children. The American Opportunity Tax Credit (“AOTC”) provides assistance for a taxpayer’s first four years of higher education.
The U.S. Treasury Department, in its Fiscal Year 2016 Financial Report, estimated that between 22.2 percent ($15.5 billion) and 25.9 percent ($18.1 billion) of the total EITC program payments of $69.8 billion were improper. The TIGTA estimated that, for FY 2015, the potential ACTC improper payment rate was 24.2 percent, with potential improper payments totaling $5.7 billion, and that the potential AOTC improper payment rate was 30.7 percent, with improper payments totaling $1.8 billion. The U.S. Treasury, in its fiscal 2016 Agency Report to Congress, attributed the high rate of overpayments in the EITC program to “the complexity of the program, the high rate of annual turnover in program participants, and the difficulty of verifying self-reported information from taxpayers claiming the credit.”
The EITC is available to qualifying individuals with low- to moderate income. To qualify for the EITC, a taxpayer must, among other requirements, either have a qualifying child, or meet all of the following requirements—
The taxpayer has reached age 25 but not age 65 by the end of the year,
The taxpayer has lived in the United States for more than half the year, and
The taxpayer does not qualify as a dependent of another individual.
A “qualifying child” is one who meets all of the following tests:
Joint tax return
To satisfy the age test, a child must—
Be under age 19 at the end of the year and younger than the taxpayer,
Be a full-time student in at least five months of the year and under age 24 at the end of the year and younger than the taxpayer, or than the taxpayer or the taxpayer’s spouse, if they file a joint return, or
Be permanently and totally disabled at any time during the year and any age.
To satisfy the relationship test, a child must be the taxpayer’s—
Son, daughter, adopted child, stepchild, eligible foster child, or a descendant of any of them (for example, the taxpayer’s grandchild), or
Brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of any of them (for example, the taxpayer’s niece or nephew).
To satisfy the residency test, the child must have lived with the taxpayer, or with the taxpayer and the taxpayer’s spouse if they file a joint return, in the United States for more than half of the year.
To satisfy the joint tax return test, the child must not have filed a joint return or if the child did a joint return, the child and his or her spouse filed the joint return only to claim a refund and were not required to file a U.S. income tax return for the year.
Such complexity invites fraud and error. Earned income tax credits are often claimed for a nonqualifying child, such as one who is a qualifying child as to another taxpayer (such as the taxpayer’s former spouse) for the year, or who does not live with the taxpayer for more than half the year.
Congress is responsible for the refundable credits problem. Using the IRS to dispense public assistance to achieve nonrevenue social goals muddles the IRS’ function as the revenue-collecting arm of the Federal government. The IRS ought not be used to administer refundable credit programs, especially where those programs, by Treasury’s own admission, are too complicated to effectively administer.
An effective revenue-raising function is essential for our country’s well-being. We need President Trump and Congress to refocus the IRS upon its essential revenue-raising function, and end refundable tax credits.
Improper payments from the Treasury increase the burden upon law-abiding taxpayers to support the federal government.
Stephen J. Dunn is a leading authority on compliance with U.S. laws concerning foreign financial assets. He has handled hundreds of foreign accounts cases for taxpayers located throughout the United States and beyond.