with Robert Weinberger
Although overall IRS audit rates are remarkably low (less than one percent), returns claiming an EITC are twice as likely to be audited as those not claiming the credit. The IRS would get a bigger bang for its buck by focusing on other noncompliant taxpayers while doing more to help workers eligible for the EITC claim correctly.
For instance, instead of requiring additional oversight on this and other tax credits, Congress should encourage IRS to shift its enforcement focus to small business noncompliance that contributes 7-10 times more to the tax gap.
The EITC is America’s largest and most successful needs-tested anti-poverty program. Annually, the credit lifts about 6 million people out of poverty, about half of them children. In 2018, the credit provided $63 billion in benefits to 25 million workers, an average of almost $2,500 per household. Importantly, it encourages people to work since the credit is equal to a percentage of earnings up to a maximum. Families with more children are eligible for larger credits and workers with children and incomes of $10,000 to $19,000 are eligible for maximum credits.
But a quarter of EITC payments are incorrect. An improper payment occurs when an EITC is paid to someone who the IRS determines was ineligible, usually for reasons of income, age, filing status, family relationship, or residence. These erroneous payments account for less than 6 percent of the $458 billion estimated annual tax gap, which is the difference between the amount of tax owed and the amount of tax paid voluntarily and on time. In contrast, sole proprietors have a 63% noncompliance rate and small businesses filing individual returns underreport $125 billion in income taxes yearly and another $65 billion in self-employment taxes, the IRS estimates.
Some EITC critics back tougher enforcement on EITC claims. But more audits alone won’t solve the problem: According to the Taxpayer Advocate’s most recent annual report, Treasury and the IRS both acknowledge that EITC improper payments are more likely due to tax filers misunderstanding complex rules than fraud.
Congress and the IRS could address the improper payment problem in the EITC by making the following changes:
- Fund improved outreach and taxpayer education – a step other countries facing similar problems have successfully used. A third of EITC claimants are new to the program each year and many are challenged by complex rules or don’t respond to IRS notices asking for documentation. However, a Taxpayer Advocate study showed over 40 percent of those who appealed their EITC denial subsequently were awarded an average of 96 percent of their original claim, suggesting that these claimants largely were entitled to the EITC on their tax returns.
- Help eligible workers claim the credit. IRS-certified volunteers provide free basic income tax return preparation to qualified individuals at 11,000 sites across the country, yet they prepare only about three percent of EITC returns. They could do more.
- Enact legislation to require testing, certification, continuing education, and better regulation of all paid tax return preparers. A paid preparer assists on over half of tax returns claiming an EITC and their aid can be vital. But one IRS study found that nearly half of these returns included a credit claim that was too high. IRS should target compliance activity on those preparers who frequently submit incorrect EITC claims either for reasons of incompetence or dishonesty.
- Ensure that all eligible workers receive the credit. About one in five workers who could claim the federal EITC don’t. In addition, many workers don’t claim state EITC benefits, which often track the federal law: 29 states, the District of Columbia, Guam and Puerto Rico have EITCs.
- Consider separating tax credits into easier-to-administer credits for workers and for children.
The IRS should take improper payments seriously. But given limited resources and competing priorities, the agency would provide a better public service by helping working families properly claim the EITC, rather than simply auditing more EITC returns. Audits should be aimed at those most responsible for the tax gap and not those who are easier to audit.