December 02, 2013
The Earned Income Tax Credit and the Costs of Improper Claims
The Earned Income Tax Credit or EITC was developed to provide benefits for working taxpayers in the low and moderate income categories. Congress originally approved this tax credit in 1975 to motivate people back to work and to provide supplements for the amounts paid into the social security system. The goal of the credit is to reduce the amount of tax owed and in certain situations provide a refund. The EITC is a refundable tax credit which means that an individual can a receive cash refund if the amount of the credit exceeds that of the taxpayer’s tax liability. The refundable portion of this credit has been covered in the news recently as the IRS has determined that improper claims for this tax credit could total as much as $133 billion over the past decade at a rate of approximately $12 - $14 billion per year.
In order to claim the EITC a taxpayer or spouse must meet all of the following requirements:
- Have valid social security number for employment
- Have earned income from working
- Filing status cannot be married filing separately
- Be U.S. citizen or resident alien for the whole year, or a nonresident alien married to a U.S. citizen or resident alien and filing a joint return
- Cannot be a qualifying child of another person
- Cannot file Form 2555 (foreign income exclusion)
- Meet the earned income, AGI and investment income limits
- Have either a qualifying child as defined or be between ages 25-65, live in the U.S. for the whole year and not qualify as a dependent of another person
Based on the above requirements, individuals can determine if they qualify for the credit and then must use the IRS’s instructions to claim the credit. The IRS gives taxpayers two options for figuring their credit. The first option for taxpayers is to file their tax return and have the IRS determine the credit for them. Allowing the IRS to complete the calculation themselves may seem easier to some taxpayers but may cause others to believe their refunds will be delayed. The second option is to use an Earned Income Credit Table in the instructions included with Form 1040. The IRS also provides an online version of this table if the individual prefers to use online tools. When taxpayers complete this form themselves, there is room for human error as well as misunderstanding of the rules.
Lawmakers claim that improper claims are caused by the complexity of the credit. The IRS believes that the most common errors in completing an EITC claim are claiming a child that does not meet all of the qualifying child tests, social security and name mismatches, using incorrect filing status, and over or under reporting income and expenses.
In 2009 Executive Order 13520 “Reducing Improper Payments and Eliminating Waste in Federal Programs” was put into place and gave the IRS the charge of setting goals for reducing the improper payments made for the EITC. The IRS has taken some steps to improve the problems with the EITC but has not been able to effectively implement what the executive order had requested of them at the current time. The IRS has been working to reduce the mistaken payments and educate those who are eligible for the credit of the requirements. They believe that it is important to balance the actions taken to curb the improper claims while still educating those who could benefit from this credit. As part of the effort to reduce improper, fraudulent and dishonest claims, the IRS states that individuals who claim the EITC are twice as likely to get audited in comparison to individuals who do not claim this credit. There are also penalty provisions to prevent individuals from inappropriately claiming the EITC if they are denied benefits due to reasons other than math or clerical errors. Depending on the final determination of the IRS, an individual can be prohibited from claiming the EITC. If the IRS finds that the taxpayer was reckless or perpetrated intentional disregard for EITC rules they will be prohibited for two years. If the IRS determines that the taxpayer committed fraud they can be barred from claiming this credit for 10 years.
Overall, the efforts of the IRS have reduced the improper payment rate from 25%-30% a decade ago to 21%-25% in 2012. The IRS conducts over half a million audits each year as part of the enforcement strategy which it claims protects around $4 billion in improper claims each year. However the amount of improper payments each year continues to top $11 billion. Lawmakers are calling for the IRS to follow executive order 13520 and reduce the improper payments starting with those of the highest value. The IRS has agreed and has stated that it will continue to develop measures to prevent the improper payments of the EITC.
The large rate of improper payments for the EITC has many lawmakers doubting that the IRS will be able to administer the billions of dollars that will be paid out as part of the Affordable Care Act. If the Affordable Care Act error rates are as big as those for the EITC there is the possibility of improper healthcare payments of approximately $250 billion. The biggest difference in these two credits is that refunds for the Affordable Care Act will be issued to the insurance companies and not individual taxpayers. Lawmakers will have to wait and see how the refundable credit provisions of the Affordable Care Act are implemented and regulated by the IRS.