Earned Income Credit
Qualifying Child Certification Test Appears Justified, but Evaluation Plan Is Incomplete Gao ID: GAO-03-794 September 30, 2003The Earned Income Credit (EIC), a tax credit available to the working poor, has experienced high rates of noncompliance. Unlike many benefit programs, EIC recipients generally receive payments without advance, formal determinations of eligibility; the Internal Revenue Service (IRS) checks some taxpayers' eligibility later. IRS estimated that tax year 1999 EIC overclaim rates, the most recent data available, to be between 27 and 32 percent of dollars claimed or between $8.5 billion and $9.9 billion. To address overclaims, IRS plans to test a new certification program. Because IRS's plans have garnered much attention, Congress asked us to (1) describe the design and basis for the EIC qualifying child certification program, (2) describe the current status of the program, including significant changes, and (3) assess whether the program is adequately developed to prevent unreasonable burden on EIC taxpayers and improve compliance so that the test should proceed.
The Assistant Treasury Secretary and IRS Commissioner convened a task force to identify ways of reducing EIC overclaims while minimizing taxpayer burden and maintaining the EIC's relatively high participation rate. In August 2002, the Secretary approved a recommendation to certify taxpayers' eligibility to claim EIC qualifying children. The proposal is based on analyses of the leading sources of EIC errors, thus focusing attention and burden on the subset of taxpayers most likely to make those errors. Since August 2002, IRS has made key changes to the certification program, including concentrating on residency certification and postponing relationship certification, delaying program implementation until later this year, and reducing the test sample from 45,000 to 25,000. Despite the changes, the process for selecting taxpayers, what taxpayers will receive from IRS, what taxpayers are required to provide, and the program's goals remain fundamentally the same as originally planned. In addition, IRS has emphasized that program expansions, if any, will depend on the results of this year's test. The process would involve three key stages. These changes, including the most recent, help achieve a better balance between preventing unreasonable taxpayer burden and addressing the EIC's high overclaim rate and support IRS's plans to test the certification program. However, IRS's plan for evaluating the test is incomplete, presenting only some information on how IRS would evaluate whether certification would reduce the EIC overclaim rate, minimize burden, and maintain a relatively high participation rate. The plan proposes potential options for identifying how and when certain critical data will be obtained, but does not provide further details on when decisions will be made or on the specific data that will be collected. Officials have developed preliminary drafts identifying data to be obtained and have begun considering how to use contractors to gather the data. Because the data relate to taxpayers' actions that will occur next spring, IRS appears to have some time to finalize its evaluation plan.
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Report to Congressional Requesters:
September 2003:
EARNED INCOME CREDIT:
Qualifying Child Certification Test Appears Justified, but Evaluation
Plan Is Incomplete:
GAO-03-794:
GAO Highlights:
Highlights of GAO-03-794, a report to congressional requesters
Why GAO Did This Study:
The Earned Income Credit (EIC), a tax credit available to the working
poor, has experienced high rates of noncompliance. Unlike many benefit
programs, EIC recipients generally receive payments without advance,
formal determinations of eligibility; the Internal Revenue Service
(IRS) checks some taxpayers‘ eligibility later. IRS estimated that
tax year 1999 EIC overclaim rates, the most recent data available, to
be between 27 and 32 percent of dollars claimed or between $8.5
billion and $9.9 billion. To address overclaims, IRS plans to test a
new certification program.
Because IRS‘s plans have garnered much attention, you asked us to (1)
describe the design and basis for the EIC qualifying child
certification program, (2) describe the current status of the program,
including significant changes, and (3) assess whether the program is
adequately developed to prevent unreasonable burden on EIC taxpayers
and improve compliance so that the test should proceed.
What GAO Found:
The Assistant Treasury Secretary and IRS Commissioner convened a task
force to identify ways of reducing EIC overclaims while minimizing
taxpayer burden and maintaining the EIC‘s relatively high
participation rate. In August 2002, the Secretary approved a
recommendation to certify taxpayers‘ eligibility to claim EIC
qualifying children. The proposal is based on analyses of the leading
sources of EIC errors, thus focusing attention and burden on the
subset of taxpayers most likely to make those errors.
Since August 2002, IRS has made key changes to the certification
program, including concentrating on residency certification and
postponing relationship certification, delaying program implementation
until later this year, and reducing the test sample from 45,000 to
25,000. Despite the changes, the process for selecting taxpayers, what
taxpayers will receive from IRS, what taxpayers are required to
provide, and the program‘s goals remain fundamentally the same as
originally planned. In addition, IRS has emphasized that program
expansions, if any, will depend on the results of this year‘s test.
The process would involve three key stages as shown below.
The EIC Certification Process as Envisioned
[See PDF for image]
[End of figure]
These changes, including the most recent, help achieve a better
balance between preventing unreasonable taxpayer burden and addressing
the EIC‘s high overclaim rate and support IRS‘s plans to test the
certification program. However, IRS‘s plan for evaluating the test is
incomplete, presenting only some information on how IRS would evaluate
whether certification would reduce the EIC overclaim rate, minimize
burden, and maintain a relatively high participation rate. The plan
proposes potential options for identifying how and when certain
critical data will be obtained, but does not provide further details
on when decisions will be made or on the specific data that will be
collected. Officials have developed preliminary drafts identifying
data to be obtained and have begun considering how to use contractors
to gather the data. Because the data relate to taxpayers‘ actions that
will occur next spring, IRS appears to have some time to finalize its
evaluation plan.
What GAO Recommends:
GAO recommends that the Commissioner of Internal Revenue accelerate
the development of IRS‘s plan to evaluate the certification test. The
plan should demonstrate how the program‘s objectives would be
evaluated, including milestones for conducting the evaluation. The
Commissioner said that IRS would further develop its evaluation plan
as we recommended.
www.gao.gov/cgi-bin/getrpt?GAO-03-794.
To view the full report, including the scope and methodology, click on
the link above. For more information, contact Michael Brostek at (202)
512-9110 or brostekm@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Task Force Considered Much Information Related to EIC Compliance before
Recommending Qualifying Child Certification Program:
IRS Has Made Key Changes to Its Initial Qualifying Child Certification
Program and More May Occur:
Qualifying Child Certification Program Developed to Improve Compliance
While Considering Taxpayers' Burden, but Plan for Evaluating Test Is
Incomplete:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendixes:
Appendix I: Significant Noncompliance Rates Other Than for the EIC:
Appendix II: Overclaim Rates, Administrative Costs, and Eligibility
Verification Processes of Benefit Programs:
Appendix III: Objectives, Scope, and Methodology:
Objectives:
Scope and Methodology:
Appendix IV: Key Milestones for the Qualifying Child Certification
Program:
Appendix V: Documents Related to the Precertification Program:
Appendix VI: Comments from the Internal Revenue Service:
Appendix VII: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Acknowledgments:
Tables:
Table 1: EIC Requirements for Tax Year 2002:
Table 2: EIC Overclaim Rates for 1997 and 1999:
Table 3: Recent Statutory Changes:
Table 4: Overclaim Rates, Administrative Costs, and Eligibility
Verification Processes for EIC and Other Programs:
Table 5: How Overclaim Rates Are Calculated for Selected Benefit
Programs:
Table 6: Questions We Were Asked:
Figures Figures:
Figure 1: Estimated Percentage of EIC Taxpayers (with Children) Who
Made Residency Errors and Filed Single or Head of Household in Tax
Year 1999:
Figure 2: IRS's Process to Identify the Population of Taxpayers from
Which the 25,000 Person Test Sample Was Drawn:
Figure 3: The EIC Certification Process as Envisioned:
Figure 4: Key Milestones for the Certification Program:
Abbreviations:
EIC: Earned Income Credit:
IRS: Internal Revenue Service:
AGI: Adjusted Gross Income:
FCR: Federal Case Registry:
SB/SE: Small Business/Self Employed:
NRP: National Research Program:
TCMP: Taxpayer Compliance Measurement Program:
Letter September 30, 2003:
The Honorable Amo Houghton
Chairman, Subcommittee on Oversight
Committee on Ways and Means
House of Representatives:
The Honorable Earl Pomeroy
Ranking Minority Member, Subcommittee on Oversight
Committee on Ways and Means
House of Representatives:
The Earned Income Credit (EIC), a tax credit available to the working
poor, has generally been considered a successful antipoverty program by
researchers. In recent years, the Internal Revenue Service (IRS) has
paid about $30 billion annually to about 20 million EIC recipients.
However, the EIC program has long experienced high rates of
noncompliance. For tax year 1999, IRS estimated the EIC overclaim
rates[Footnote 1] ranged between 27 and 32 percent of dollars claimed
or between $8.5 billion and $9.9 billion. Unlike many benefit programs,
EIC recipients generally receive payments without a prior, complete
review of their eligibility; IRS checks some aspects of taxpayers'
eligibility before and after the credit is granted.
To help combat the high rates of noncompliance, IRS plans to test a new
program, beginning in December 2003.[Footnote 2] Referred to as the
qualifying child certification program, some taxpayers will be asked to
verify EIC "residency" requirements[Footnote 3] for their qualifying
children before getting that portion of their refund or reduction in
tax liability. IRS plans to test the EIC program with 25,000 taxpayers
whose residency cannot be confirmed through other means. Future plans
for the program largely depend upon the results of this test.
Because IRS's plans surrounding the program have garnered much
attention, you asked us to respond to questions about the qualifying
child certification program. These questions cover various topics, such
as the status of the program, understandability of letters and forms
going to taxpayers, certification requirements and taxpayers' ability
to comply, taxpayer burden, impact on compliance rates, impact of
recent legislative changes, and data from other federal or state
benefit programs. We grouped these questions into three objectives: (1)
describe the design and basis for the EIC qualifying child
certification program as proposed by the EIC task force, (2) describe
the current status of the program, including significant changes since
program approval, and (3) assess whether the program is adequately
developed to (a) prevent unreasonable burdens on EIC taxpayers and (b)
improve compliance so that the test should proceed. In addition, you
asked us to provide readily available information on the (1)
significant noncompliance rates other than for the EIC and (2)
overclaim rates and administrative costs of comparable benefit programs
administered by states or the federal government and any verification
process used by these programs. This information is presented in
appendixes I and II, respectively.
This report is based primarily on our previous work and analysis of IRS
and Department of the Treasury documents and reports, new letters and
forms that will be sent to taxpayers, and interviews with senior
officials at IRS and Treasury. We did not verify the accuracy of
reports or data obtained. Rather, we reviewed the steps IRS officials
had taken to implement the program and determined, to the extent
possible, how they assured themselves that the program had been
adequately developed to prevent unreasonable burden and improve
compliance. We did not determine the adequacy of various other
preparations for the qualifying child test, such as staffing and
training of staff. Appendix III provides more detail on the scope and
methodology used in conducting our work.
Results in Brief:
Due to persistently high EIC noncompliance, among other factors, the
Assistant Secretary of the Treasury and IRS Commissioner convened a
task force in February 2002 to find ways of reducing EIC overclaim
rates while minimizing the burden to taxpayers and maintaining the
EIC's relatively high participation rate. The task force considered the
likely effect of recent legislative changes on EIC compliance in
formulating its proposal to combat noncompliance. It also considered
various options, such as partnering with other federal or state
agencies to verify EIC taxpayers' eligibility. The task force analyzed
data and reviewed studies to design the program to focus on known
sources of noncompliance. In August 2002, the Treasury Secretary
approved the task force recommendation that IRS certify the eligibility
of taxpayers' qualifying children. Only taxpayers most likely to make
errors and whose qualifying child eligibility cannot be verified from
available information would be asked to certify.
Since taking its broad charge from the task force, IRS obtained input
from external and internal stakeholders, and made key changes to the
certification program, including (1) concentrating on residency
certification and postponing the relationship certification for an
undetermined period of time, (2) delaying program implementation until
later this year, and (3) reducing the test sample from 45,000 to
25,000. According to IRS officials, the relationship portion of the
program was postponed indefinitely for several reasons, including
concerns raised about the proposed relationship certification form and
studies that have shown meeting requirements for relationship is less
of a compliance issue than meeting residency requirements. IRS had
previously changed the start date of the test, and, as we were
finalizing this report, announced in August 2003, that it was again
delaying the program and now plans to send letters about the qualifying
child certification program to taxpayers in December 2003. With this
change, taxpayers will now have to provide proof that qualifying
children meet the residency test when they file their 2003 individual
income tax returns; thus, any unresolved issues could result in frozen
refunds. As part of the August announcement, IRS also reduced the
number of taxpayers that will be included in the test from 45,000 to
25,000, in part, in response to comments received during a 30-day
public period. However, these changes create additional challenges for
IRS and taxpayers. For example, the test will no longer be a direct
test of the original concept of certifying taxpayer eligibility in
advance of the filing season. At the same time, the process for
selecting taxpayers, what taxpayers will receive from IRS, and what
taxpayers will be asked to provide to prove the residency of a
qualifying child remains basically the same as originally planned.
Further, IRS officials have emphasized that program expansions, if any,
will depend on the results of the test.
The changes made in the proposed certification program--including the
ones announced in August--help achieve a better balance between
preventing unreasonable taxpayer burden and addressing the EIC's high
overclaim rate, and support IRS's plans to move forward with the
residency test. The qualifying child program is based on analyses of
the leading sources of EIC errors, thus focusing attention and burden
on the subset of taxpayers making those errors as opposed to all EIC
recipients. In addition, IRS has taken steps to address the burden
taxpayers will experience as participants in the test this year.
However, IRS's plan for evaluating the results of the test is not yet
complete. Although an evaluation plan does not have to completely
identify all issues or how they will be evaluated prior to a program's
start, the more completely a plan is developed, the more likely that
the evaluation will be sufficient to support future decisions. The
draft evaluation plan presents only some information on how IRS will
show whether certification's objectives--reduce the overclaim rate,
minimize burden, and maintain the EIC's relatively high participation
rate--will be achieved. However, the plan proposes potential options
for identifying how and when some critical data will be obtained and
analyzed, but does not provide further details on when, how, and by
whom decisions will be made on the specific data that will be
collected. Officials have developed preliminary drafts identifying data
to be obtained and have begun considering how to use contractors to
gather the data. Since the data relates to taxpayers' actions that will
occur next spring, IRS has some time to finalize the evaluation plan.
We are recommending that the Commissioner of Internal Revenue, to the
extent possible, accelerate the development of the evaluation plan, and
have the plan demonstrate how each program objective will be evaluated,
including milestones for critical steps such as how data will be
obtained and analyzed in time to support decisions about the future of
IRS's certification program.
We requested comments on a draft of this report from the Commissioner
of Internal Revenue. We received written comments, which are reprinted
in appendix VI. In his comments, the Commissioner said that IRS would
be including the components we suggested in their evaluation plan and
said that IRS is working to incorporate these components well before
the certification test begins. We further discuss the Commissioner's
comments in the "Agency Comments and Our Evaluation" section of the
report.
Background:
Congress enacted the EIC in 1975[Footnote 4] with the goal of
offsetting the Social Security taxes paid by the working poor and
creating a greater work incentive for low-income taxpayers. According
to data cited in the task force report, an estimated 4.3 million
individuals were lifted out of poverty in 1998 by the EIC, including
2.3 million children.
The EIC is a refundable tax credit, meaning that qualifying working
taxpayers may receive a refund greater than the amount of income tax
paid during the year. Taxpayers can qualify for the credit in one of
two ways: with a "qualifying child" or by "income only," if they do not
have a qualifying child. For example, for tax year 2002, the amount of
EIC that could be claimed with a qualifying child or children ranged
from $0 to $4,140. EIC payments have a phase-in range in which higher
incomes yield higher EIC amounts, a plateau phase in which EIC amounts
remain the same even as income rises, and a phase-out range in which
higher incomes yield lower EIC payments or tax liability.
EIC requirements for tax year 2002 include rules for everyone,
additional rules for taxpayers with qualifying children, and additional
rules for taxpayers without qualifying children, as shown in table 1.
Table 1: EIC Requirements for Tax Year 2002:
Rules for all taxpayers claiming the EIC: Must have a valid Social
Security number; Additional rules for taxpayers with a qualifying
child: Income limitations: If one child: $29,201 (or $30,201 if married
filing jointly). If more than one child: $33,178 (or $34,178 if married
filing jointly); Additional rules for taxpayers without a qualifying
child: Income limitations: $11,060 (or $12,060 if married filing
jointly).
Rules for all taxpayers claiming the EIC: Cannot use married filing
separately status; Additional rules for taxpayers with a qualifying
child: Child must meet age, relationship, and residency tests;
Additional rules for taxpayers without a qualifying child: Must be at
least 25 years old, but under 65.
Rules for all taxpayers claiming the EIC: Must be a U.S. citizen or
resident alien all year; Additional rules for taxpayers with a
qualifying child: Child can be claimed by one taxpayer only; Additional
rules for taxpayers without a qualifying child: Taxpayer cannot be the
dependent of another person.
Rules for all taxpayers claiming the EIC: Cannot file form 2555 or
2555-EZ; Additional rules for taxpayers with a qualifying child:
Taxpayer cannot be a qualifying child of another taxpayer; Additional
rules for taxpayers without a qualifying child: Taxpayer cannot be a
qualifying child of another taxpayer.
Rules for all taxpayers claiming the EIC: Investment income must be
$2,550 or less; Additional rules for taxpayers with a qualifying child:
[Empty]; Additional rules for taxpayers without a qualifying child:
Must have lived in U.S. more than half of a year.
Rules for all taxpayers claiming the EIC: Must have earned income.
Source: IRS.
[End of table]
IRS has periodically measured EIC compliance for overclaims and
underclaims. The most current data available, for tax year 1999, show
EIC overclaim rates estimated to be between 27 and 32 percent of
dollars claimed or between $8.5 billion and $9.9 billion. IRS has
limited data on underclaims, which for tax year 1999 were estimated to
be between $710 million and $765 million.[Footnote 5] IRS has tried to
reduce noncompliance through various means, including education and
outreach to taxpayers and tax return preparers. In addition, Congress
has enacted legislation aimed at resolving some concerns with EIC
rules. Because a new analysis of EIC compliance using 2001 tax return
information is not expected to be complete until late in 2004, IRS does
not know whether compliance has significantly changed since 1999, but
officials do not think it has improved
substantially. Because of the persistently high rates of noncompliance,
we have identified the EIC program as a high-risk area for IRS since
1995.[Footnote 6]
Currently, taxpayers claim the EIC by filing an individual income tax
return (e.g., a Form 1040 or 1040A) and including a Schedule EIC--a
procedure similar for claiming other tax credits. Unlike with other
benefit programs such as Supplemental Security Income, however, EIC
taxpayers are not required to be found qualified before claiming the
credit or file any other documents with their return to establish
eligibility. Instead, IRS uses four primary means to evaluate EIC
eligibility and check for noncompliance after the return is filed and
checks some aspects of taxpayers' eligibility before and after the
credit is granted: (1) the math error program, (2) correspondence and
face-to-face examinations (also called audits), (3) the document
matching program, and (4) criminal investigations. Some of these means,
such as the math error program, check all EIC returns, but only for
limited aspects of eligibility. Other means, such as examinations, only
check a small subset of EIC returns, but the review is more expansive.
In general, IRS subjects all returns to its math error program and
takes corrective action on errors found. Depending on the resources IRS
has available, IRS works only a small portion of cases identified as
potentially meriting follow-up under its examination, document
matching, and criminal investigations efforts.
While processing all tax returns, IRS uses its automated math error
program to identify and correct the simpler errors found in claiming
the EIC. For example, the math error program can identify invalid
Social Security numbers and taxpayers who fail to follow
recertification requirements.[Footnote 7] As a result, some
inappropriate EIC claims are stopped before refunds are issued. During
fiscal year 2001, IRS stopped more than 371,000 incorrect EIC claims
using its math error authority. After identifying errors, IRS corrects
them so the tax return can be processed and sends a computerized notice
to the taxpayer identifying the error and stating that IRS disallowed
or reduced the EIC claim. The notice tells taxpayers that if they can
correct the error, the EIC claim will be allowed and any refund related
to the EIC claim will be issued.
Two types of examinations---correspondence and face-to-face--are used
when EIC noncompliance is suspected, in most cases before refunds are
issued. IRS uses various systematic means to "score" the likelihood of
noncompliance on any return and uses experienced staff to manually
identify the specific items on returns for examination. Most EIC
examinations occur shortly after a return is filed, largely because of
the difficulty in recovering refunds. IRS stops refunds on these
returns until examinations are completed. This contrasts with IRS's
normal examination practice of performing examinations many months
after tax returns have been processed and any refunds paid. The EIC
examinations usually rely on correspondence with taxpayers rather than
face-to-face contacts. IRS completed about 368,000 EIC related
correspondence exams during fiscal year 2002. IRS tends to use face-to-
face meetings with taxpayers to examine tax returns with EIC claims on
a very limited basis and primarily when examinations are initiated for
other reasons. As part of either type of examination, however, IRS
would describe the potential noncompliance in a computerized notice to
taxpayers claiming the EIC. IRS requests documentation, such as a
school record or birth certificate, to establish EIC requirements.
Depending on whether IRS officials accept or reject the support, they
may make changes to the return and refund related to the EIC claim. If
taxpayers disagree with IRS's decisions, they have the right to appeal
administratively and/or through the courts.
IRS also uses its document matching programs to identify potentially
misreported income on tax returns claiming the EIC. By comparing the
tax return to wage and income statements provided by third parties such
as employers and financial institutions, the document-matching program
identifies whether a taxpayer appears to have misreported income. Given
the phase-in and phase-out ranges of the EIC, some taxpayers may claim
too much EIC by overreporting or underreporting their income. This
program notifies such taxpayers months after returns are filed and
refunds are issued. Similar to audits, a notice is issued telling a
taxpayer that an error appears to have been made, that he or she may
disagree and provide any support for income reported, and that he or
she may appeal IRS's decision about additional taxes owed. Unlike
audits, the program is highly automated and is designed to require less
contact with taxpayers by IRS staff.
IRS also uses criminal investigations to stop the payment of false
refunds, identify refund scams/schemes, and prosecute perpetrators,
including those with fraudulent EIC claims. For EIC, IRS uses a
specific computer program that looks for questionable refund claims and
for return preparers known to have prepared questionable returns. IRS
also has teams that scan returns and receive referrals from other parts
of IRS and informants. IRS stops many returns as they are being
processed so that criminal investigators can review the claims before
the refund is paid or after the return has been processed.
Task Force Considered Much Information Related to EIC Compliance before
Recommending Qualifying Child Certification Program:
When IRS's study of EIC compliance rates for 1999 was released, the
Assistant Secretary of the Treasury and IRS Commissioner convened a
task force in February 2002 to find ways of reducing EIC overclaims
while minimizing the burden to taxpayers and maintaining the EIC's
relatively high participation rate. The task force considered whether
changes in statutes recently enacted by Congress or proposed by
Treasury may have lessened the need for new EIC compliance initiatives
and concluded that, while statutory changes addressed some sources of
noncompliance, they likely would not reduce other leading sources of
noncompliance. The task force also considered a range of new methods,
including partnering with other federal or state agencies or programs
and developing a new database to verify EIC eligibility before issuing
tax refunds, but decided that these options were not viable.
Ultimately, the task force recommended the qualifying child
certification program. The task force reviewed IRS's EIC compliance
study results and other data, as well as other studies, to identify the
sources and develop new methods of addressing noncompliance.
Task Force Convened to Address Long-Standing Compliance Problem:
The joint Treasury and IRS task force addressed a long-standing problem
of high EIC overclaim rates. Although the release of IRS's 1999
compliance study precipitated the formation of the EIC task force in
February 2002, the study results were generally consistent with high
overclaim rates reported in prior IRS studies. While some stakeholders
view the 1999 study as having some methodological weaknesses, it showed
that of the approximately 20 million taxpayers that claimed the EIC in
1999, 46 to 50 percent of their tax returns had errors that led to
claiming too much of the credit (IRS often refers to this as the error
rate). IRS also estimated that the total dollars overclaimed on those
returns represented between 27 and 32 percent of total EIC dollars
claimed in 1999, or between $8.5 billion and $9.9 billion. IRS also has
some data on underclaims--instances where taxpayers claimed less than
they were entitled to receive. For tax year 1999, underclaims were
estimated to be between $710 million and $765 million.
IRS has conducted EIC compliance studies for several years and the
overclaim rate, which is the percentage of total dollars paid out in
error, was estimated to be about 24 percent in tax year 1994. According
to IRS officials, because different methodologies were used in the
subsequent studies, changes in estimated overclaims found in other
studies do not support conclusions about trends in the overclaim rate
over time. However, IRS officials also acknowledged the overclaim rate
has not improved significantly. Overclaim rates for tax years 1997 and
1999 are shown in table 2. The information in table 2 does not reflect
the current compliance situation; for example, it does not reflect the
presumably positive impact of new legislation that has taken effect
since 1999 aimed at improving compliance.
Table 2: EIC Overclaim Rates for 1997 and 1999:
Tax year: 1997; Lower-bound rate: 23.8%; Upper-bound rate: 25.6%.
Tax year: 1999; Lower-bound rate: 27.0%; Upper-bound rate: 31.7%.
Source: IRS data.
Note: Because not all individuals responded to audit contacts, IRS uses
certain assumptions to estimate the overclaim rate range. The lower-
bound rate assumes that the overclaim rate for the nonrespondents is
the same as for the respondents, while the upper-bound assumes that all
nonrespondents are overclaims.
[End of table]
Although IRS's studies have shown high EIC overclaim rates for many
years, other studies had shown that EIC's participation rate was fairly
high. For example, in 2001 we reported that an estimated three of every
four eligible participants received the EIC in tax year 1999.[Footnote
8] For taxpayers with one or two qualifying children, we estimated that
participation rates exceeded 90 percent. Individuals with no children,
who receive a much smaller credit than taxpayers with qualifying
children, had a much lower participation rate that we estimated to be
about 45 percent. Although at the time we reported that available data
did not enable us to determine the reasons for these differences, IRS
officials attributed these differences, in part, to the lower EIC
amounts allowed for individuals and because the program did not include
individuals without children when it first began.
Task Force Reviewed Recent Legislative Changes Likely to Improve
Compliance:
The EIC task force reviewed whether recent statutory changes have the
potential to reduce the major sources of EIC noncompliance, either by
changing the rules or providing IRS new enforcement options. Because
the study of tax year 1999 compliance was the most recent available,
the task force lacked data on the effect of the recent changes and
relied on other analyses that showed whether the changes would affect
compliance. Of the recent changes, the task force estimated that one
change, to the Adjusted:
Gross Income (AGI) tiebreaker rule,[Footnote 9] would likely reduce
noncompliance. The task force judged that the other legislative
changes, including those proposed by Treasury, while potentially
helping reduce noncompliance from other sources, would not be enough to
reduce noncompliance without further IRS efforts.
Three key pieces of legislation, which have been recently enacted or
taken effect, were at least partially aimed at improving EIC
compliance, as shown in table 3. They may eventually help reduce
noncompliance after taxpayers and tax preparers become familiar with
the new laws. The statutory changes were to serve several purposes,
including improving compliance and simplifying tax laws associated with
the EIC.
Table 3: Recent Statutory Changes:
Law: Economic Growth and Tax Relief Reconciliation Act of 2001(P.L.
107-16, March 7, 2001); Change: This act made several changes,
including (a) effective for tax years after December 31, 2001,
simplifying the "Adjusted Gross Income tiebreaker rule," (b) for tax
years beginning after December 31, 2001, establishing a new definition
for earned income by eliminating non-taxable earned income and by
having the Earned Income Credit (EIC) based on adjusted gross income,
(c) for tax years beginning after December 31, 2001, amending the
definition of a foster child by reducing the residency requirement to
over half a year, and (d) effective January 1, 2004, allowing the IRS
to use math error authority to deny EIC claims if the Federal Case
Registry (FCR) indicates that the taxpayer is the noncustodial parent
of the qualifying child with whom the credit is claimed.
Law: Ticket to Work and Work Incentives Improvement Act of 1999 (P.L.
106-170, December 17, 1999); Change: Effective after December 31, 1999,
part of this act simplified the definition of a foster child.
Law: Tax Relief Act of 1997 (P.L. 105-34, August 5, 1997); Change:
After October 1,1998, this act requires that each record in the state
registry include the Social Security number of any child for whom
support has been ordered. This information is included in the FCR
database. It also requires an applicant for a Social Security number
who is under age 18 to provide his or her parent's Social Security
numbers, in addition to other required evidence, such as age, identity,
and citizenship.
Source: GAO analysis of legislation.
[End of table]
A Treasury study showed that the change in the AGI tiebreaker rule
effective for tax years after December 31, 2001, would likely have
eliminated about $1.4 billion of the nearly $2 billion in tax year 1999
EIC overclaims that were due to tiebreaker errors. Accordingly, the
task force decided that this source of EIC overclaims did not need to
be further addressed by a new compliance initiative.
Although officials recognized the benefits of these recent legislative
changes to help improve EIC compliance, they concluded that additional
initiatives were still needed. For example, officials recognized the
value of IRS being able to use math error authority to deny EIC claims
on and after January 1, 2004, when the Department of Health and Human
Services' Federal Case Registry (FCR) indicates that the taxpayer is
the noncustodial parent of the qualifying child. However, officials
told us that this authority was limited and not applicable to a
significant number of taxpayers whose compliance may be problematic.
IRS has a study in process to determine the effectiveness of using FCR
data to deny EIC claims using its math authority. The study was
scheduled for completion by July 30, 2003, but as of August 20, 2003,
was not yet completed.
Task Force Considered Three Alternatives to Improve Qualifying Child
Compliance:
The EIC task force considered three key options to verify taxpayers'
qualifying children: (1) partnering with other federal or state
agencies or government programs to verify EIC taxpayers' eligibility,
(2) creating a federal database that would automatically match and
detect questionable or erroneous EIC claims, and (3) certifying
taxpayers' eligibility for certain EIC criteria. Ultimately, in August
2002, the Secretary of the Treasury approved the qualifying child
certification program, which at the time was to include providing proof
of eligibility in advance of the filing season (July-December), and was
referred to as "precertification.":
The first two options were expected to impose little or no
documentation requirements on taxpayers. The task force was trying to
determine for both options whether sufficient information was already
available from others, or that little additional information would need
to be collected by others, to verify a taxpayer's qualifying children.
However, the task force found that there was little overlap between the
EIC population and verification criteria used to administer other
federal or state programs. In addition, although some databases
existed, the task force found that they could not be used to
effectively verify EIC eligibility, largely for the same reason.
Consequently, the task force judged that these options were not likely
to be useful in addressing EIC compliance problems. Similarly, the task
force also found that if a federal database were created to facilitate
EIC verification, IRS would have to gather the bulk of the information
itself, thus imposing a burden on taxpayers, which would also be costly
and time-consuming for IRS. The third option, which the task force
selected, required taxpayers to demonstrate EIC eligibility for certain
criteria, namely residency and relationship tests for qualifying
children, prior to receiving the credit.
The relative cost of the options the task force considered did not
drive the decision to select the qualifying child program because the
other two alternatives were not considered viable. The task force did
compare IRS's EIC administrative costs to those of other federal
benefit programs and found them to be much smaller. IRS has had a
special appropriation for EIC compliance initiatives since 1998--and
has received about $875 million total through fiscal year 2003. It
requested a total of about $250 million in fiscal year 2004, which
included $100 million for the EIC compliance initiatives, including the
qualifying child program, and about $150 million for the special
appropriation. IRS estimated that this $250 million[Footnote 10] total
was about 0.8 percent of the total annual EIC benefits distributed, and
therefore much smaller than the 9 to 13 percent administrative costs
the task force had found for other benefit programs. See appendix II
for more information we obtained on administrative costs for other
benefit programs.
Task Force Reviewed Studies and Data to Design Initiatives Focused on
Known Sources of Compliance Problems:
The EIC task force reviewed IRS studies, other IRS data, and studies by
other parties to better understand the sources of EIC noncompliance and
devise new initiatives to address those known sources. In reviewing IRS
studies and data, the task force found that the three leading sources
of EIC errors resulting in overclaims in 1999 were (1) claiming
nonqualifying children incorrectly, accounting for about $3 billion,
(2) using the wrong filing status, accounting for about $2 billion, and
(3) misreporting income, also accounting for about $2 billion. Three
administrative proposals resulted, involving (1) qualifying child
certification, (2) improper filing status, and (3) income
misreporting.[Footnote 11] In 1999, another leading source of EIC
overclaims involved taxpayers with lower modified adjusted gross income
claiming a child when another person with a higher income should have
done so. The task force did not propose an initiative dealing with
these errors, primarily because the "AGI tiebreaker" legislation was
specifically enacted to decrease this source of noncompliance, as
previously discussed.
To deal with the error attributable to claiming children who are not
EIC qualifying children, the task force proposed a qualifying child
certification program. Based on analyses of past compliance data, IRS
found that taxpayers who overclaimed the EIC, most frequently claimed
children who did not meet the residency or relationship
criteria.[Footnote 12] As a result, the task force proposed the
qualifying child program that was to include an annual residency
certification and a one-time relationship certification.
Under this program, during the period from July through December,
taxpayers would have been asked to document that the children they
intend to claim under the EIC, meet the EIC relationship and residency
criteria. The task force proposed targeting the program to those
taxpayers with qualifying children for whom IRS could not establish
residency or relationship through other available means and it proposed
that this concept be tested on a sample of EIC taxpayers for the tax
year 2003. The task force envisioned that ultimately all EIC claimants
whose eligibility could not be verified through available means would
be asked to provide additional eligibility documentation prior to the
filing season. Taxpayers who successfully certified qualifying
children's eligibility in advance of the filing season would have their
claims processed and paid expeditiously during the filing season,
absent any other problems with their tax return or EIC claim. Having
taxpayers certify between July and December was also intended to allow
IRS to process the taxpayers' documents outside of the filing season
when IRS processing systems are in highest demand. Taxpayers who did
not respond and/or were unable to document their eligibility during the
certification period, but then claimed the EIC when they submitted
their tax returns, would have the EIC portion of their tax refund
frozen. Then they would be required to provide the same documentation
during or after the filing season as they were asked to provide during
the certification period. When and if they document their eligibility,
the EIC portion of their refunds would be released.
Process for Identifying Taxpayers When IRS Planned to Certify for
Relationship:
According IRS officials, as the task force neared its end and before
the Secretary of the Treasury approved the program, IRS developed a
means for using existing data to determine whether each taxpayer likely
would meet the relationship or residency test for children they had
claimed for EIC for tax year 2002. For relationship, IRS developed a
plan to match taxpayers to several databases that show the parents of
children. For instance, one database IRS planned to use was the Social
Security Administration's database (which IRS refers to as KIDLINK)
that ties parent's and children's Social Security numbers for children
born after 1998 in U.S. hospitals. For tax year 2003, IRS had planned
to match 1.6 million, or 10 percent of the approximately 16 million EIC
taxpayers with a qualifying child, to the databases. Under this
scenario, any taxpayer who was not shown to be the parent of a
qualifying child claimed for tax year 2002 would then be part of the
population from which IRS would randomly select taxpayers to test for
relationship.
Process for Identifying Taxpayers to Certify for Residency:
IRS considered the work of the task force in developing a comparable
means for using available data to identify those who have met the
residency criterion. The task force had analyzed data from the 1999
compliance study and information in other reports.[Footnote 13] It
found that residency errors related to qualifying children were often
correlated with the taxpayer's relationship to the child and the
taxpayer's filing status and gender. The analysis showed that, overall,
parents who filed married filing jointly were the most compliant when
compared to taxpayers filing single or head of household in claiming a
qualifying child who meets the residency test. Married filing jointly
parents had the fewest qualifying child residency errors--1.5 percent-
-compared to any other combination of taxpayers by relationship to the
child, gender, or tax filing status. Among taxpayers who file single or
head of household, mothers were the most compliant (see figure 1).
Figure 1: Estimated Percentage of EIC Taxpayers (with Children) Who
Made Residency Errors and Filed Single or Head of Household in Tax Year
1999:
[See PDF for image]
Note: This figure reflects residency errors only. Mothers who filed as
single or head of household, for example, made qualifying child
residency errors 3.4 percent of the time, while 96.6 percent of the
time, they either made no errors or errors other than residency-related
errors.
[End of figure]
The task force also found other reports that reinforced the results of
its analysis. Specifically, an independent study of low-income
households in three urban areas estimated that children resided with
biological mothers 90 percent of the time. Another study estimated that
89 percent of children in low-income households lived with both parents
or their mother.
IRS used this information to propose a process for identifying
taxpayers to include in the population that would be subject to the
residency certification requirement. IRS proposed that the 1.6 million
taxpayers, or 10 percent of the 16 million taxpayers with a qualifying
child, would be matched to the FCR database. IRS officials considered
the FCR to be the most useful database for identifying those meeting
the residency requirements. This database compiles court and other
records that indicate who is the custodian for a child (which could be
a parent or nonparent). IRS assumes that children live with the
custodian of record. According to IRS, the FCR database contains
custodial information for about 40 percent of the EIC population. If a
taxpayer matched as the custodian of the child claimed for the EIC for
2002, the taxpayer would not
be among those needing to certify. When the FCR database showed someone
was the custodian of a child other than the EIC taxpayer who had
claimed that child for the EIC in 2002, those taxpayers would be among
the group from which the residency certification sample would be drawn.
When the FCR contains no information about the child a taxpayer had
claimed for EIC in 2002, the IRS would attempt to establish the
relationship of taxpayers to qualifying children by comparing
information in several databases. Those taxpayers IRS could identify
from databases as the child's mother would be excluded from the sample,
if they filed married filing jointly, single, or as head of household.
Mothers would be excluded on the basis of the task force analyses
showing mothers to be among the most compliant on the residency
criterion. Also excluded from the sample would be fathers who filed as
married filing jointly. Otherwise, all males who were shown to be a
child's father filing single or head of household would be included in
the group from which the certification sample would be drawn because of
the data showing a high level of noncompliance on the residency
criterion for these taxpayers. Finally, all nonparents who are not
shown in the FCR to be the custodian would go into the group from which
taxpayers would be selected for residency certification, also due to
information showing nonparents to be among the less compliant taxpayers
on the residency criterion. The selection processes for relationship
and residency would have, therefore, yielded a group of taxpayers that
would include some needing to certify for relationship only, some for
residency only, and some to certify for both.
IRS Has Made Key Changes to Its Initial Qualifying Child Certification
Program and More May Occur:
Since adopting the EIC task force recommendations in August 2002, IRS
has made key changes to the qualifying child certification program in
response to input received and additional analyses done. Some of these
changes include (1) postponing relationship certification for an
undetermined period of time, (2) delaying program implementation, and
(3) reducing the test sample from 45,000 to 25,000. However, these
changes create additional challenges for IRS and taxpayers. Despite
these challenges, the process for selecting taxpayers, what taxpayers
will receive from IRS, and what taxpayers will be required to provide
remains basically the same as originally planned. According to
officials, the same factors were considered when setting the new sample
size, which is still designed to allow IRS to achieve the same goals as
the original sample size, albeit to a lesser extent.
In addition, IRS has emphasized that program expansions, if any, will
depend on the results of this year's test. Concerns we identified in
our report on recertification[Footnote 14] were considered and taken
into account by IRS in designing the new qualifying child certification
program.
IRS Broadly Adopted Task Force Recommendations in Its Initial Design of
the Qualifying Child Certification Program:
IRS took the broad charge from the EIC task force and designed the
qualifying child certification program. Its focus was to decrease the
EIC overclaim rate while striving to maintain the high rate of
participation and minimize taxpayer burden. Initially, IRS decided that
the certification program would involve:
* testing of 45,000 taxpayers for both relationship and residency
beginning in July 2003, and:
* immediately expanding the certification program for relationship to 2
million taxpayers in 2005 and to both relationship and residency in
substantial numbers in future years.
However, as IRS obtained input on the program, it modified these plans.
Certification for Residency Only Is to Begin in December 2003 for
25,000 Taxpayers:
Since initially formulating plans for the qualifying child
certification, IRS has made multiple changes to the program. First, IRS
postponed relationship certification for an undetermined period for a
number of reasons. IRS had developed a draft form for certifying
relationships and obtained input on the form from external and internal
stakeholders. Some stakeholders raised concerns about whether taxpayers
would be able to provide some of the types of documentation IRS planned
to request, such as marriage certificates, within the time envisioned.
IRS officials said that testing the relationship certification this
year was postponed, in part, because these concerns were unresolved.
The officials also noted that Treasury studies have shown relationship
requirements to be a lesser compliance issue than residency, and
taxpayers that were found to be noncompliant with relationship
requirements were also often noncompliant due to residency errors.
Since both residency and relationship requirements have to be met, if
taxpayers fail certification on residency there would be no need to
test on relationship. Consequently, officials gave a higher priority
for testing residency certification.
Second, IRS has changed the start date of the test twice. Originally,
IRS planned to start the test in July 2003, but postponed
implementation until mid-August. As we were finalizing this report, IRS
announced in August that it now plans to begin the test in December
2003, in conjunction with the 2004 tax filing season. (Appendix IV
shows key milestones from 2002 through 2005.) According to IRS
officials and documents, implementation was postponed from July to
August to allow time to conduct focus group testing, request and obtain
public comments during a 30-day period, and make changes to the program
as a result of those efforts. Thereafter, IRS postponed implementation
a second time from August to December to ensure (1) taxpayers have
better access to tax practitioners since many only operate during the
filing season and (2) more time for outreach and education.
However, as a result of the delays, taxpayers will be providing proof
of residency documentation during the filing season and not
"precertifying" before the filing season as originally envisioned. This
change is important and creates additional challenges for both IRS and
taxpayers, as follows:
* Taxpayers will no longer have the opportunity to provide proof of
qualifying child residency, correspond with IRS in advance of the
filing season, and resolve any potential issues before filing their tax
returns. Because all correspondence will take place during the filing
season, selected taxpayers could experience a delay in receiving the
EIC portion of any refund, if the EIC portion is frozen because of any
problems until certification is successfully completed.
* IRS will no longer be able to spread out its workload and processing
may be slower since certification will occur during the filing season-
--IRS's busiest time of year.
* IRS will not have the opportunity to assess taxpayers' ease or
difficulty in obtaining required documentation in advance of the filing
season and whether taxpayers would do so. This is important because
taxpayers may be given the opportunity to certify in advance of the
filing season in future years.
Third, IRS reduced the number of taxpayers included in the test from
45,000 to 25,000, in part, in response to comments received during the
30-day public period. According to IRS officials, despite reducing the
number of taxpayers included in the test, the sample size should still
allow IRS to make statistically valid measurements of results in
addition to helping IRS meet its desired goals of protecting revenue
and testing the process for conducting the certification program. In
addition, the smaller sample should help mitigate the challenge related
to processing the certification forms during the filing season.
Process for Selecting Taxpayers, What They Will Receive, and What They
Will Provide to IRS Remains Basically the Same:
Despite these changes, how IRS selected taxpayers for the test, what
taxpayers will receive from IRS, and what taxpayers will be asked to
provide as proof of residency for qualifying children will remain
fundamentally the same. IRS's process for selecting the taxpayers for
the test is shown in figure 2.[Footnote 15] Using this process, IRS
selected 25,000 taxpayers in August. The 25,000 represents about 0.16
percent of the approximately 16 million EIC claimants with a qualifying
child in tax year 2002 and about 0.13 percent of the approximately 20
million EIC recipients overall.
Figure 2: IRS's Process to Identify the Population of Taxpayers from
Which the 25,000 Person Test Sample Was Drawn:
[See PDF for image]
[A] The FCR contains custodial and welfare assistance data. If there
is a match showing that the taxpayer is the child's custodian,
regardless of the taxpayer's gender, filing status, or relationship to
the child, IRS assumes the child resides with the taxpayer.
[B] These taxpayers are excluded, based on (1) IRS compliance data that
show married filing jointly parents are 20 times more compliant on
residency than nonparents, and single or head of household mothers are
10 times more compliant on residency than single or head of household
fathers and (2) private studies that show about 90 percent of children
in low income households live with their mother or both parents.
[C] IRS estimates that using the FCR and other databases will exclude
almost 75 percent of the 1.6 million taxpayers. Therefore, about
402,000 taxpayers were included in the population from which IRS drew
the certification sample.
[End of figure]
According to agency officials, IRS will now send the 25,000 taxpayers
forms and instructions about the program in December instead of this
summer. IRS plans to send Notice 84-A, a letter informing them about
the new program; Form 8836, "Qualifying Children Residency Statement;"
Publication 3211M, "Earned Income Tax Credit Question and Answers;" and
Publication 4134, "Free/Nominal Cost Assistance Available for Low
Income Taxpayers." However, officials are changing these documents
based on the public comments received. Appendix V has the most current
copies of these documents.
Once taxpayers receive this information from IRS, they would obtain
documentation to prove the qualifying child's residency and send it
back to IRS. IRS examiners would review the documentation and send a
letter back to the taxpayer either accepting or rejecting the claim, as
shown in figure 3.
Figure 3: The EIC Certification Process as Envisioned:
[See PDF for image]
[End of figure]
IRS currently envisions that the 25,000 taxpayers selected for
certification will be required to provide proof that the qualifying
child meets residency requirements before getting the EIC portion of
their refund. IRS officials say that taxpayers who are able to
establish eligibility when filing their tax return should receive their
refunds more expeditiously than those who do not. Taxpayers selected
for certification but who are not able to provide the necessary
documentation will be treated essentially the same as taxpayers
undergoing a correspondence audit. The EIC portion of their refund--if
they are to get one--will be frozen until proof of eligibility is
established.
Same Factors Considered When Setting Smaller Sample Size:
According to IRS's draft evaluation plan for the certification test and
our discussions with officials, three factors were considered in
setting the original sample size of 45,000: (1) show that certification
would "protect revenue," (2) determine whether the test will succeed,
and (3) test its processes and systems. According to IRS officials, the
smaller sample size of 25,000 is designed to allow IRS to achieve the
same goals as the original sample size, albeit to a lesser extent.
One factor considered by IRS for the certification test was to stop as
large an amount of EIC overclaims due to ineligible qualifying children
as possible during the 2003 tax year. To determine how many taxpayers
to include in the certification test to achieve this goal, officials
said they determined the maximum number of staff that could be assigned
to and adequately supported by the planned central unit in Kansas City
that would be responsible for the certification program. Based on the
maximum number of staff that could be assigned and assumptions about
how many cases staff could handle, IRS calculated that 45,000 taxpayers
could be included in the test. IRS estimated that $114.5 million in
protected revenues could be realized from including 45,000 taxpayers in
the test. Based on the revised sample size of 25,000, IRS now estimates
that $63.6 million in protected revenues could be realized.
A second factor considered was to have a large enough sample to support
analyses of whether the test succeeds. For instance, IRS is interested
in how many taxpayers provide the information needed for IRS to
determine qualifying child eligibility, whether taxpayers in the sample
population who are actually qualified to claim the EIC do not do so
with their 2003 tax return and why, and whether taxpayers found the
certification process burdensome. IRS's draft plan for evaluating the
certification test notes that the original 45,000 sample size was much
larger than needed to obtain statistically valid measures of test
results. The draft plan indicated that a sample size of about 3,600
taxpayers, which would have provided an estimate at 95 percent
confidence levels plus or minus 5 percent, was the number of taxpayers
needed for IRS to determine qualifying child eligibility. According to
the draft plan, the 45,000 sample size would allow very precise
estimates for the population as a whole and should provide
statistically valid information about sub-sets of claimants. Despite
the reduction to 25,000, IRS officials still believe that this sample
size will allow for precise estimates for the universe as a whole and
smaller subsets as well.
Finally, a third factor in selecting both the 45,000 and 25,000 sample
sizes was to have a large enough sample to test the processes and
systems that would be required if IRS were to expand certification in
the coming year. IRS had been preparing to work on approximately 25,000
certification cases during the filing season under its original plan
for 45,000 taxpayers. It based the 25,000 on worst case assumptions
about how many of the 45,000 would not opt to submit proof of
eligibility in advance of the filing season and, instead, would have
submitted their documentation during the filing season. In addition,
for this goal, the draft plan preceded IRS's current thinking that the
certification program likely will not be expanded as rapidly next year,
if expanded at all. However, according to IRS officials, based on the
number of cases IRS estimates can be worked on and what it plans to
achieve under this goal, the 25,000 sample size is appropriate to help
test the systems and processes.
Future Expansion of Certification Program Depends on Test Results:
Although IRS has consistently referred to the certification effort as a
test, officials recently have stressed this point. For example,
officials have recently referred to the efforts for this year as a
"pilot or proof of concept." Furthermore, as a result of the most
recent changes, the program will no longer take place in advance of the
filing season, but instead, during the filing season. IRS officials
told us that it is unlikely that the certification program will be
expanded to cover 2 million claimants in the summer of 2004, as
originally anticipated. Instead, IRS officials plan to assess the
program's overall effectiveness and make any necessary modifications
before expanding it to additional EIC claimants in the future. Thus,
particularly in light of IRS's most recent announcement and according
to IRS officials, the program may be expanded more slowly, if at all,
depending upon the evaluation results. Officials also said that test
results will contribute to a future decision about whether
certification, if continued, will precede the filing season or be part
of the filing season as it will be this year.
Input from Focus Groups and Others Has Resulted in Changes and May
Result in More:
On the basis of stakeholder input, focus groups, and other input, IRS
has made several changes to the planned certification test in addition
to those discussed previously. IRS held informal meetings with external
and internal stakeholders, focus group meetings with taxpayers and paid
preparers, and one-on-one interviews with third parties to share the
certification letters, forms, and/or instructions and obtain views on
aspects of the new process. In response, IRS took several actions,
including revising the forms. As of August 2003, IRS was evaluating
comments received during the 30-day public comment period, which IRS
officials said may result in additional changes.
IRS held several informal meetings with external and internal parties
with an interest in the qualifying child certification program. In
March 2003, the Stakeholder Partnership, Education, and Communication
Organization[Footnote 16] and the National Taxpayer Advocate held four
informal meetings with various external stakeholders, such as
representatives of the National League of Cities, the Boston EIC
Coalition, and the American Institute of Certified Public Accountants.
Similarly, IRS officials coordinated the certification initiative with
internal stakeholders, such as representatives from the Compliance
unit, Wage and Investment operating division, Small Business/Self
Employed (SB/SE) operating division, and Forms and Publications unit.
The purpose of these meetings was to discuss the EIC certification
proposal and share the drafts of the two new certification tax forms--
Form 8836, "Qualifying Children Residency Statement," and Form 8856,
"Qualifying Child Relationship Statement." Officials told us they
received comments from these groups of stakeholders and revised and
improved the forms based on the feedback received. For example, for the
residency form IRS added a list of community-based organizations and a
list of acceptable third parties from which IRS would accept
affidavits.
After incorporating the recommendations from these informal meetings,
officials said they felt comfortable with testing the Form 8836, its
instructions, and the accompanying letter in other ways, including
focus groups, one-on-one interviews, and a 30-day public comment
period.[Footnote 17]
In June 2003, a contractor conducted nine focus groups, five with
taxpayers who claimed EIC in tax year 2002, and four with tax preparers
who had prepared returns for taxpayers claiming EIC. In addition to the
focus groups, the contractor also conducted nine one-on-one interviews
with a cross section of the third parties listed on Part IV of the Form
8836 (the participants were landlords, employers, and child care
providers). The goal of the testing was to determine whether
individuals understood the documents and thought they could obtain the
requested supporting documents and whether the suggested third parties
would be willing to sign the affidavit.
The focus groups and interviews were held in Philadelphia, Chicago,
Dallas, and Los Angeles. These cities were selected because of their
high EIC population. The participants were selected using screening
guidelines developed by IRS in conjunction with the contractor.
Taxpayers were selected on the basis that they claimed the EIC for tax
year 2002 with a qualifying child. Similarly, preparers were selected
on the basis that they worked as a tax preparer on federal tax returns
for 2002 and prepared tax returns for clients claiming EIC with a
qualifying child. Those selected for one-on-one interviews represented
a cross section of the types of individuals IRS deemed credible to
provide affidavit information about the EIC claimant. In total, 816
people were contacted and 109 agreed to participate in the focus group
testing. Of the 109, 88 persons arrived for the testing and 81 actually
participated in the focus groups. For the one-on-one interviews, 12
individuals were qualified to participate and 9 actually participated
in the interviews.[Footnote 18]
Key IRS officials were on site during the focus groups and one-on-one
interviews to observe the participants' comments. A variety of comments
were received and some changes were made. For example, IRS highlighted
where taxpayers and third parties were to sign the forms. Although the
contractor's report of these meetings was not available before the
public comment period, IRS officials who attended the meetings
concluded that they had not received any feedback that would preclude
moving forward with getting comments from the public.
During the comment period, anyone could write or go to IRS's Web site
and provide any comments or opinions about the qualifying child
certification program, including the form IRS expected to use and the
data it planned to request to prove eligibility. According to IRS,
during the 30-day public comment period, IRS received about 200
communications containing comments. Any other comments about the
certification program are due by December 31, 2003. In addition,
individuals can comment on the certification process during the filing
season until April 15, 2004. As of August 2003, IRS officials were
reviewing the comments received and anticipated making additional
changes to the forms and publications shown in appendix V.
Our Concerns with IRS's Recertification Were Considered as IRS Designed
the Qualifying Child Certification Program:
IRS officials told us they considered the recommendations in our
recertification report[Footnote 19] when planning their certification
program. We agree that our applicable recommendations have been
considered. Whether the strategies IRS adopted to deal with the
concerns that led to our recertification report recommendations are
successful will not be known until IRS evaluates the certification
test.
Our recertification report described three aspects of the
recertification process that caused problems for taxpayers.
Specifically,
* one form used for recertification was of questionable value to IRS
and another form was potentially confusing to taxpayers;
* taxpayers were asked to submit information that was difficult for
them to obtain or inconsistent with what many IRS examiners considered
acceptable; and:
* IRS examiners' inconsistent assessment of documentation submitted by
taxpayers could result in different recertification decisions for
taxpayers in similar circumstances.
IRS has taken steps to deal with all of these concerns in designing the
certification process. Regarding the problems with recertification
forms, the form that was of questionable value to IRS, which was
essentially a means for taxpayers to tell IRS that they wished to be
considered for recertification, is not applicable to the certification
program. The other recertification form told taxpayers what they had to
submit to establish their eligibility for the EIC. We found that this
form could confuse taxpayers into believing they had to show that a
qualifying child was also their dependent, a criterion not applicable
to EIC eligibility. We also found that the form provided insufficient
guidance to taxpayers on what information they needed to provide to
prove that qualifying children met the EIC eligibility requirements. We
made several recommendations, including that IRS should clarify
taxpayers do not need to demonstrate that qualifying children are also
dependents, help taxpayers better understand what documentation they
need to provide to establish their relationship with any qualifying
children, eliminate a requirement that statements from child care
providers be notarized, and encourage taxpayers to submit more than one
type of documentation.
Regarding our concerns about taxpayers who were recertifying being
asked to submit documentation that was difficult for them to obtain and
that tax examiners did not all accept, we found, for example, that EIC
taxpayers' living arrangements could make providing various documents
difficult. We also found taxpayers did not always understand that
school records were for a calendar year and therefore needed to cover
the spring and fall of separate school years. We also found situations
in which IRS examiners would not accept a document even though the
recertification form listed the document as being acceptable. This
concern overlapped with our finding that IRS examiners' were
inconsistent in their assessment of whether documentation provided by
the taxpayers was sufficient to establish their qualifications for the
EIC.
Regarding our concerns about inconsistent documentation, IRS again took
actions intended to deal with our concerns in developing the
certification program. By introducing a new option--obtaining an
affidavit affirming that a qualifying child resided with the taxpayer
for more than half the year--IRS intended to give taxpayers another
means of showing that the residency requirement is met, which would
prevent the taxpayer having to obtain the other types of documents that
the draft certification form lists. Although IRS did not, as we
recommended, create a new form to be used by taxpayers when seeking
school records, it did follow our alternative recommendation that IRS
clearly remind taxpayers that they need records for part of 2 school
years. The information is included in the certification form's
instructions, which contain an example where a taxpayer must provide
records from 2 school years. Finally, by centralizing the EIC
certification processing in one location--Kansas City--and providing
training to those who will be involved, IRS is seeking to ensure a
higher level of consistency in how tax examiners judge whether
taxpayers adequately establish that qualifying children meet the
residency criterion for EIC.
Whether the manner in which IRS took our recertification
recommendations into account when designing the certification program
will be successful will not be known until IRS evaluates the
certification test.
Qualifying Child Certification Program Developed to Improve Compliance
While Considering Taxpayers' Burden, but Plan for Evaluating Test Is
Incomplete:
The certification program appears to be adequately developed to
potentially improve EIC compliance with consideration for minimizing
taxpayer burden so that testing should proceed, particularly in light
of IRS's recent announcement further delaying the program's start and
reducing the sample size. For example, the EIC task force and IRS have
taken steps that directly minimized the number of taxpayers who will be
burdened by the certification program. That is, the certification
proposal is based on analyses of the leading sources of EIC errors
detected in earlier studies, thus focusing attention and burden on the
subset of taxpayers making those errors, as opposed to all EIC
recipients. In addition, IRS has taken steps to address the burden
taxpayers will experience as participants in the certification test
this year.
Although IRS has made and is continuing to make progress in defining
its plan to evaluate the certification test, the plan is incomplete.
For example, the draft plan does not indicate how and when some
information that will be needed to evaluate whether certification
achieves its objectives will be obtained and analyzed. However,
officials recognize the draft plan needs to be further developed and
the importance of doing so quickly.
Initial Design and Subsequent Changes May Improve EIC Compliance and
Have Helped to Minimize Burden:
In initially designing and subsequently modifying the EIC certification
program, officials took into account the burden that taxpayers may
experience while attempting to improve compliance. Officials designed
the program to include, and thus burden, only the taxpayers most likely
to make the errors that contribute most to the EIC's overclaim rate. By
focusing on these noncompliant taxpayers, IRS expects to improve EIC
compliance. In addition, officials took a number of steps, such as
obtaining input from external and internal stakeholders that resulted
in changes and delaying the program while considering comments received
during the comment period, which should reduce the burden on those
taxpayers who are identified to certify.
To help improve compliance, the task force focused on known sources of
noncompliance including claiming nonqualifying children, filing
status, and misreporting income. To deal with errors attributable to
claiming nonqualifying children, the task force proposed a program for
certifying the eligibility for qualifying children and envisioned
targeting taxpayers most likely to make those errors. In contrast,
other benefit programs that we reviewed generally require all
applicants to provide documentation before receiving assistance. For
example, to receive Supplemental Security Income, an individual must
visit a Social Security office, meet with a representative, and provide
documentation including birth certificates and payroll information. The
Social Security Administration then matches this information to
determine eligibility in advance of benefits being received. IRS's
certification effort, even if fully implemented, would require only a
subset of all EIC taxpayers to provide documentation to support their
eligibility and only when IRS is unable to verify eligibility from
other sources of information.
After the proposal was formally adopted, IRS took a number of steps in
developing plans for implementation that have been intended at least in
part to minimize the burden that taxpayers actually asked to certify
would experience, including the following.
* IRS has undertaken more activities than usual to ensure the residency
form and other explanatory documents related to the certification
program have been reviewed by those who would use them.[Footnote 20]
IRS sought feedback from focus groups and stakeholders on various
aspects of the certification test and the draft letter, form, and
instruction proposed for the residency test, such as whether taxpayers
will be able to obtain and provide documents within the time available,
and made some changes to the proposed form due to that feedback. As
previously described, IRS held focus groups with taxpayers, paid tax
preparers, and other parties to obtain feedback on certification.
Officials also interviewed a small number of third parties who would be
called upon to provide requested documents. IRS also held a 30-day open
period to receive comments from any interested party and expects to
revise certification materials due to comments received. Finally, IRS
officials say they will again revisit, among other things, the
appropriateness of the forms and explanations going to taxpayers after
evaluating the results of this year's test of certification.
* IRS considered the issues we raised in our report about the
recertification program[Footnote 21] when planning for certification.
For example, as discussed previously in this report, IRS developed a
standard form that includes an affidavit, which taxpayers can provide
to third parties, such as an employer, as an alternative to obtaining
other documents to prove residency. We also noted in our report that
examiners inconsistently accepted or declined supporting documentation
for recertification purposes. To address this concern, IRS officials
conducted special training and have all certification examiners in one
location, Kansas City, where EIC claims will be processed.
* IRS provided taxpayers with a variety of documentation choices in
order to prove eligibility for their qualifying children. To certify
for residency, taxpayers will need to provide Form 8836, "Qualifying
Children Residency Statement," with one or more of the following
supporting documents:
* school records, medical records, day care provider records, leases,
or social service agency records that show the parent's name and the
child's name and address, and the dates that the child lived with the
parent; or:
* a letter on official letterhead for a qualifying child from the
child's school, health care provider, landlord, or member of the clergy
that shows the parent's name and the child's name and address, and
dates that the child lived with the parent; or:
* a third party affidavit from a clergy member, community-based
organization official, health care provider, landlord or property
manager, school official, or day-care provider.
* IRS dropped for an undetermined period of time, its plan to ask
taxpayers to certify their relationship to qualifying children. IRS
officials do not know whether or if they will test certification of
relationships in the future. Various external stakeholders had
expressed concerns about whether taxpayers would be able to provide the
type of documents, such as marriage and birth certificates, which IRS
had planned to request to document relationships to qualifying children
on time. Also, IRS officials said that the relationship portion of the
program was dropped for other reasons, including that (1) studies that
have shown relationship requirements to be less of a compliance issue
than residency and (2) taxpayers found to be noncompliant because of
relationship requirements often were also noncompliant due to residency
errors. As a result, certification will only include residency this
year.
As part of its effort to balance burden with ensuring compliance, IRS
made the changes listed above. As we drafted this report, it had not
yet determined what additional changes it would make to the forms on
the basis of comments received during the 30-day public comment period,
but officials said more changes will likely result. As previously
discussed, the initial design of the residency form was responsive to
concerns we raised in our earlier report on IRS's recertification
program. Additional changes, especially dropping relationship
recertification, were responsive to the concerns that stakeholders
raised before the public comment period. Accordingly, the current draft
residency certification form addresses many burden concerns.
IRS's Plan for Evaluating the Test Is Incomplete:
Although IRS has made and is continuing to make progress in defining
its plan to evaluate the certification test, the plan is not yet
complete. From its inception, the certification program was intended
to: (1) reduce the EIC's overclaim rate, (2) minimize burden on
taxpayers and (3) maintain the EIC's relatively high participation
rate. Although there are many ways to organize an evaluation,
determining whether the major objectives of a program are accomplished
should help policymakers determine whether and how to proceed with the
program. The draft plan is not explicitly organized to show whether
certification's objectives are achieved, but does present some
information on how IRS would evaluate these objectives. However, the
plan proposed potential options for identifying how and when some
critical data will be obtained and analyzed, but does not provide
further details on when decisions will be made on specific data that
will be collected, how, and by whom. Officials recognize that the draft
plan needs to be further developed and the importance of doing so
quickly. They have, for instance, developed preliminary drafts
identifying additional data needed and have begun considering how to
use contractors to gather the data. Because evaluating these objectives
will depend in part on actions of EIC certification participants that
will now occur as part of next year's filing season, IRS appears to
have some time before it must make final decisions on how it will
determine whether the objectives were met.
Although an evaluation plan may not have to completely identify all
issues that need to be evaluated and precisely how they will be
evaluated before a program begins, the more completely such a plan is
developed before a program is implemented, the more likely that the
evaluation will be sufficient to support future decisions. For example,
identifying key questions that need to be answered before a project's
implementation increases the chances that necessary data will be
collected to answer those questions. IRS's Internal Revenue
Manual[Footnote 22] recognizes the desirability of having evaluation
plans in place before a project is implemented. For instance, it
requires such plans before reorganizations.
IRS has been preparing an evaluation plan for the certification test
and has a draft plan, dated April 22, 2003. That draft describes how
IRS expects to evaluate the program and the process IRS used to select
taxpayers for the test.
The draft plan identifies one "threshold" question for evaluating the
certification program: whether the claimant selected for the test
provided the required information to allow IRS to determine the
eligibility of qualifying children regardless of whether the claimant
was determined to be eligible or not. The plan lists data that are to
be gathered throughout the certification program to answer this
question.
The threshold question is part of what must be included in determining
whether certification for residency helps lower EIC overclaims, but
additional information is needed. Although not tying methodologies or
planned data collection specifically to whether certification lowers
the EIC overclaim rate, the draft plan has a combination of approaches
that should contribute to answering this question. For example, the
draft plan identified data that IRS would gather throughout the test on
how many taxpayers in the test sample certify or fail to do so in
advance of the filing season as well as how many prove that children
meet the EIC residency test during the filing season.[Footnote 23]
The extent to which certification may reduce overclaims due to
qualifying children not meeting the residency requirement, however,
will depend significantly on why some taxpayers will not attempt to
certify and why some will fail to claim the EIC, or as much EIC, for
tax year 2003 as they did for 2002. The draft plan takes into account
that some taxpayers may receive the certification materials, determine
that a child does not meet the residency test, and therefore not
attempt to certify and not claim the EIC with their 2003 tax return or
claim EIC on another basis. IRS expects to use available data to help
assess whether the taxpayer had a filing requirement and whether the
taxpayer may have been eligible to claim the EIC (e.g., did the
taxpayer's income fall within the appropriate range?). In addition, the
draft plan proposes that IRS use a contractor or another third party to
gather information from taxpayers about why they did not claim the EIC.
A subsequent document cites ideas for the types of questions that could
be asked.
Regarding the burden certification imposes on taxpayers who
participate, the plan is not organized to show how this will be
evaluated, but it recognizes that participants' burden should be
evaluated. For example, the data IRS plans to collect throughout the
process will have some utility in answering this question. IRS will
keep track of the number of communications back and forth between IRS
and the taxpayer before a tax examiner makes a final certification
decision. IRS's plan also recognizes that some information on burden
will need to be collected directly from taxpayers. The plan includes a
general description of a potential opinion survey that would gather
burden-related information from certification participants. Little or
no detail is provided on how taxpayers would be selected for such a
survey, what types of questions would be asked, and when the survey
would be done; however, some of this information is shown in a
subsequent draft document. Because taxpayers will not have completed
their certification experience until sometime next filing season, IRS
has some time to decide whether to do such a survey and how to define
its parameters.
Regarding the objective of maintaining the EIC's relatively high
participation rate, the draft plan proposes to obtain information from
those taxpayers who are asked to certify, do not, and then fail to
claim the EIC. The plan proposes to use a contractor or other third
party to gather information from these taxpayers about why they did not
claim the EIC. The plan does not amply describe how and when final
decisions would be made about selecting contractors or another third
party to do this, when the contractor would contact taxpayers, or what
data they would attempt to obtain from the taxpayers. Because the
population IRS will need to contact for these surveys will not be known
until during and after the spring of 2004, IRS has a number of months
to further develop and implement an approach.
Recognizing that its plans need to be further developed, IRS officials
have continued to explore how the evaluation will be done. For example,
officials have drafted ideas for the type of survey questions a
contractor or other party would ask of EIC taxpayers to help IRS assess
why taxpayers take, or do not take, various actions (such as why they
may stop claiming the EIC after being asked to certify eligibility) and
to assess taxpayers' experiences under the certification program,
including the burdens they experience. In addition, officials have
begun identifying potential contractors who would perform the surveys
and considering contracting options. According to IRS officials and
documents, some discussions have been held with potential contractors
to gain a better understanding of ways to test the survey instruments,
techniques available to ensure the best possible response rate, and the
number of taxpayers needing to be contacted to have useful results.
Finally, because IRS would like to undertake some version of the
qualifying child program next year, possibly including certification
during the latter part of 2004, the timely production of evaluative
data for this year's test will be critical for supporting decisions
about what form future efforts will take. IRS is aware of the tight
schedule. Officials note that while they will not have complete
information on which to base some decisions about whether and how to
continue with implementation in 2004 before those decisions must be
made, they expect to have preliminary data in a timely fashion. For
example, IRS will not be able to completely answer whether, and if so,
why, taxpayers who are legitimately qualified to receive the EIC do not
claim it when they file their 2003 tax return until the end of the 2003
tax filing season, or later if taxpayers request a filing extension.
IRS does expect that its contractor will have contacted many, if not
most, of the taxpayers who file returns before the end of the filing
season and do not claim EIC. Thus, IRS expects to know during the fall
of 2004 why many taxpayers in the certification test stop claiming the
EIC.
Some Implementation Issues Not Reviewed:
We did not evaluate some implementation issues because they were
outside the scope of our review, still under development, or the
Treasury Inspector General for Tax Administration had audits planned in
these areas. Nonetheless, implementation issues could affect whether
IRS is able to fully implement the certification test and ultimately
improve compliance. We did not assess (1) whether IRS assigned an
appropriate number of staff to assist taxpayers with questions and
process the forms and documents relating to certification, (2) the
adequacy of training materials for staff or the procedures put in place
to help examiners consistently accept or decline taxpayers' supporting
documentation, (3) the design or reliability of the databases that will
be used to capture and evaluate program information, and (4) supporting
tools, which examiners will use to do their job.
IRS has developed broad plans for processing the certification
workload. Officials identified about 30 different offices that will be
affected by the new certification program. As a key part of its
processing strategy, IRS plans to dedicate employees at its Kansas City
campus to process cases, answer a special toll-free number, and make
updates to a certification database based on responses from the test of
the 25,000 taxpayers. The Kansas City site will have about 180 staff,
the bulk of whom will come on-board between September and December
2003. Approximately 40 staff took initial training between April and
June 2003.
Conclusions:
Given the persistently high EIC overclaim rates, that the certification
program is a test, and that IRS has taken key steps to address burden
issues and focus the test on individuals least likely to meet the
qualifying child residency requirements, we believe IRS has struck a
reasonable balance between preventing unreasonable burden on EIC
taxpayers and balancing the need to obtain information on whether
certification can be a useful approach to improving EIC compliance. In
addition, with the recent program changes announced in August, it
appears that IRS is taking even more steps to be mindful of these
concerns. Although certification during the 2004 filing season gives
IRS somewhat more time to modify the forms and take other actions to
potentially further reduce the burden on taxpayers subject to the test,
it also creates new challenges for IRS. The test will no longer be a
direct test of the original concept of certifying taxpayer eligibility
in advance of the filing season. Instead, testing will occur during the
filing season--IRS's busiest time of year--and gives IRS only indirect
evidence on how well certification may work before the filing season as
originally envisioned. Further, because IRS currently plans for
taxpayers to have to successfully provide proof of eligibility when
they file their individual income tax return or have a refund frozen
until they do, a greater portion of the taxpayers chosen for the test
may have their refunds delayed than if certification had been done
before the filing season. Finally, like virtually all aspects of the
qualifying child certification program, IRS's future plans have yet to
be determined and are largely dependent of the results and subsequent
evaluations of this test.
For various reasons, we did not review in detail some implementation
issues, such as staffing and procedures for handling taxpayer
responses, which could affect whether IRS is able to successfully
implement the certification test. Thus, our opinion on whether IRS is
ready to proceed is based only on whether it has adequately developed
the test to prevent unreasonable burden and to improve compliance.
Although the balance IRS has struck supports proceeding with the test,
IRS's plan for evaluating the certification program test is incomplete.
IRS recognizes the need to evaluate the test and is developing its plan
to do so. For some key test objectives, IRS has preliminarily
identified some data that it believes must be collected to determine
whether certification's objectives are achieved and has broadly
identified when and how that information will be collected. Because the
data are related to taxpayers' actions that will occur later this year
or next spring, IRS appears to have some time to finalize its
evaluation plan.
Recommendations for Executive Action:
Given that the qualifying child certification program is a key part of
IRS's plans for reducing EIC overclaims and that certification is
intended to help reduce overclaims while minimizing the burden on
taxpayers and maintaining the EIC's participation rate, the
Commissioner of Internal Revenue should, to the extent possible,
accelerate development of the evaluation plan for the test. The plan
should demonstrate how each of the certification's objectives will be
evaluated, including milestones for such critical steps as defining the
specific data that will be collected, who will collect the data, and
how the data will be analyzed in time to support decisions about the
future of the program.
Agency Comments and Our Evaluation:
While not explicitly agreeing with our recommendation, in his September
22, 2003, letter, the Commissioner of Internal Revenue said that IRS
would be including the components we suggested in their evaluation plan
and said that IRS is working to incorporate these components well
before the certification test begins. The Commissioner said that our
discussion of the evaluation plan is essentially accurate, but provided
an enclosure to his letter that noted supplemental information on the
plan. We are aware of the information described in the enclosure to the
Commissioner's letter, and considered it when drafting our report.
The Commissioner also raised concerns about the comparability of EIC
error rates to the error rates in taxpayers' reporting of certain types
of income. We concurred that, by-and-large, the compliance data on
reporting of these types of income are not comparable to the EIC error
rate. As a result, we no longer show those comparisons in our final
report.
We are sending copies of this report to the Chairmen and Ranking
Minority Members of the Senate Committee on Finance and the House
Committee on Ways and Means. We are also sending copies to the
Secretary of the Treasury; the Commissioner of Internal Revenue; the
Director, Office of Management and Budget; and other interested
parties. We will make copies available to others on request. In
addition, the report will be available at no charge on the GAO Web site
at [Hyperlink, http://www.gao.gov.] h [Hyperlink, http://www.gao.gov]
ttp://www.gao.gov.
This report was prepared under the direction of Joanna Stamatiades,
Assistant Director. Other major contributors are acknowledged in
appendix VII. If you have any questions about this report, contact Ms.
Stamatiades at (404) 679-1900 or me on (202) 512-9110.
Signed by:
Michael Brostek
Director, Tax Issues:
[End of section]
Appendixes:
Appendix I: Significant Noncompliance Rates Other Than for the EIC:
The IRS has compliance data on some taxpayer groups such as individuals
and small businesses and some tax items such as income and credits. By-
and-large, the compliance data IRS currently has are not comparable to
the EIC. IRS is implementing its National Research Program (NRP), which
will provide new compliance data in 2004. In the meantime, IRS is using
its Strategic Planning and Performance Management process to prioritize
compliance issues.
The compliance data that IRS has available for some taxpayer groups and
tax items are largely based on the Taxpayer Compliance Measurement
Program (TCMP),[Footnote 24] which was last conducted in 1988. However,
these data cannot be compared to the EIC overclaim or error rates, in
part because these data are 15 or more years old and reliable
inferences cannot be drawn because much of the tax system and the
economy have changed during that time. In addition, the methods used to
calculate compliance rates for TCMP are different than those used to
calculate EIC.
In late 2002, IRS began implementing its new NRP, a detailed study of
individual taxpayers' compliance.[Footnote 25] As part of NRP, IRS has
identified a random sample of approximately 47,000 returns from tax
year 2001 and is in the process of verifying the information on the
returns through reviews of IRS and third-party data. Where necessary to
confirm the accuracy of taxpayer-reported information, IRS is
conducting either correspondence or face-to-face examinations. IRS
intends to conduct additional NRP reviews of additional types of
taxpayers, such as small corporations, and use the NRP periodically to
measure compliance of individual taxpayers.
The NRP sample of 47,000 returns includes about 7,300 EIC returns.
These EIC returns are subject to the same processes as the other
returns in the sample, and will include a review of the taxpayers'
eligibility for the EIC. In order to determine whether the NRP review
of these returns will yield results methodologically similar to those
of the 1999 EIC compliance study, IRS is also comparing the results of
the 1999 compliance study with NRP by putting a sample of returns from
the 1999 study through NRP processes (not including examinations).
According to IRS officials, this should allow them to see the impact of
the methodological differences between the compliance study and NRP
review. IRS expects the results of the comparison study by September
2003. IRS plans to have preliminary NRP results in May 2004 and final
results in November 2004.
Until better compliance measurement data are available, IRS's
organizational divisions use the Strategic Planning Budgeting and
Performance Management process to prioritize the compliance problems
IRS faces. Through this process, IRS says that it (1) identifies and
explores critical trends, issues, and problems, (2) develops
operational priorities and improvement projects to address existing or
emerging problems, (3) explores drivers of program resources in order
to develop resource allocation targets for carrying out the proposed
strategies, and (4) enables division commissioners and the senior
leadership teams to prioritize the strategies and projects and
determine the resource requirements to apply to each strategy,
operational priority, and improvement project.
Based on managers' judgments made during this process, the Small
Business/Self Employed (SB/SE) operating division, for example,
identified its top six compliance priorities for fiscal year 2003 and
2004:
* high income nonfilers (income greater than $100,000),
* abusive offshore financial transactions,
* promoter investigations (those selling tax schemes to others),
* abusive tax avoidance transactions,
* high income taxpayers (income greater than $1 million), and:
* returns with a high probability of unreported income.
SB/SE, which conducts few examinations of EIC claims, did not consider
EIC in this prioritization exercise since EIC has its own dedicated
appropriation.[Footnote 26] Because IRS used different means to
identify and prioritize these potentially noncompliant taxpayer groups,
their identification as SB/SE priorities does not mean their
noncompliance rate is comparable to noncompliance rates established for
EIC or rates, which will be determined through the current or future
NRPs or other EIC compliance studies.
[End of section]
Appendix II: Overclaim Rates, Administrative Costs, and Eligibility
Verification Processes of Benefit Programs:
In addition to the data we complied on IRS's EIC and qualifying child
certification program, we also compiled overclaim rate and
administrative cost data, as well as information on the eligibility
verification processes, for nine other federal or state benefit
programs. We selected the nine benefit programs because each requires
some type of certification for benefits, similar to the EIC, and
because the EIC task force reviewed the same programs. We did not do a
comprehensive analysis to determine which programs, if any, are most
comparable to the EIC, nor did we determine whether the information
reported is comparable across programs.
The overclaim rates, administrative costs, and the eligibility
verification processes for the EIC and the other nine benefit programs-
--Unemployment Insurance, Supplemental Security Income, Social
Security Disability Insurance, the National School Lunch program, the
Food Stamp program, Housing and Urban Development rental assistance,
Medicaid, Medicare, and Temporary Assistance for Needy Families---are
shown in table 4.
Overclaim rates for programs other than the EIC for which data were
available ranged from 0.2 to 10.7 percent. These overclaim rates
reflect the percentage of total dollars paid out in error, not, for
example, the percentage of claimants who made errors.[Footnote 27] To
calculate the overclaim rates, most of the nine agencies selected a
sample of program participants and conducted a detailed analysis of the
cases. This can involve collection of additional supporting
documentation, personal contacts with employers and other third
parties, or home visits to program recipients. A description of how the
overclaim rates were calculated is in table 5.
Administrative costs range from $123 million to $11.9 billion for the
nine programs. Administrative costs reported by federal agencies are
likely not comparable across programs and may not include all of the
costs involved in administering the programs. For example, various
agencies and entities at the federal, state, and local levels have
administrative responsibilities under the National School Lunch
program. However, while the federal budget provides funds separate from
program dollars to pay for administrative processes at the federal and
state level, officials at the local:
level pay for administrative costs from program dollars that include
federal and state funding and student meal payments.[Footnote 28]
The process used to determine and validate eligibility varies
significantly. Some programs, such as the school lunch program, rely
primarily on self-reported information and verification is limited.
Other programs, such as the Food Stamp program, require program staff
to conduct extensive verification.
Table 4: Overclaim Rates, Administrative Costs, and Eligibility
Verification Processes for EIC and Other Programs:
Program: Earned Income Credit; Overclaim rate[A]: 27-32 percent; (tax
year 1999); Administrative cost: $145 million[B]; (tax year 1999);
Eligibility verification process: Currently, no certification
requirement exists. An EIC claimant's return is selected for
examination when it meets certain selection criteria that points to
potential overclaim. When this occurs, documentation is generally
requested to establish requirements for EIC and related issues using
document request forms including for qualifying child, filing status,
and dependency issues.
Program: Unemployment Insurance; Overclaim rate[A]: 8 percent[C];
(fiscal year 2001); Administrative cost: $2.3 billion[D]; (fiscal year
2001); Eligibility verification process: Eligibility for unemployment
insurance benefits is determined under state law, so the information
applicants are required to provide varies by state. States rely heavily
on self-reported information; in some states applicants can apply over
the telephone or on-line. Only a limited number of states independently
verify claimants' identity by using the Social Security
Administration's State Online Query system, which can match a
claimant's name, date of birth, and Social Security number. States may
use independent automated data sources to verify other eligibility
factors such as wages and employment status.
Program: Supplemental Security Income; Overclaim rate[A]: 7.2
percent[E]; (fiscal year 2001); Administrative cost: $2.8 billion[E];
(fiscal year 2002); Eligibility verification process: Supplemental
Security Income is available to individuals who are blind or disabled
and poor. The amount of Supplemental Security Income an individual
receives depends on several factors including, but not limited to,
other sources of income and living arrangements. To apply for
Supplemental Security Income, applicants must visit a Social Security
office and meet with a Social Security representative. Examples of
documentation required under the program include: (1) social security
card; (2) birth certificate or other proof of age; (3) mortgage or
lease; (4) payroll slips, bank books, insurance policies, and other
records about income and assets; (5) names and addresses of doctors (if
disabled); and (6) proof of United States citizenship or noncitizen
status. To verify this information, the Social Security Administration
uses computer matches to compare Supplemental Security Income records
against recipient information contained in records of third parties,
such as other federal and state government agencies. The Social
Security Administration periodically conducts "redetermination"
reviews to verify eligibility factors such as income, resources, and
living arrangements. Recipients' eligibility is to be reviewed at least
every 6 years.
Program: Social Security Disability Insurance; Overclaim rate[A]: 0.2
percent[E]; (fiscal year 2001); Administrative cost: $2.0 billion[E];
(fiscal year 2001); Eligibility verification process: Social Security
Disability Income provides income support benefits to former workers
who have suffered a long-term disability. Applicants can start their
application online, but before they are approved for benefits,
applicants must provide the following documentation to a social
security office: (1) a Social Security number; (2) birth certificate or
other proof of age; (3) medical information, such as names and
addresses of doctors and medical records; (4) work history for the
prior 15 years; and (5) a W-2 or tax return.
Program: School Lunch; Overclaim rate[A]: Not known; Administrative
cost: $123 million[F]; (fiscal year 2002); Eligibility verification
process: Households submit applications with self-reported
information, including the names of household members and all sources
of income for each household member, and the Social Security number of
the adult that signs the application. Alternatively, children with
Temporary Assistance for Needy Families or Food Stamp case number can
be certified directly. Generally, no documentation or additional
support is requested at the time of application. Local authorities
verify eligibility for free and reduced price meals for a sample of
applications using either random or focused sampling techniques.
Program: Food Stamps; Overclaim rate[A]: 8.66 percent[G]; (fiscal year
2001); Administrative cost: $2.4 billion[H]; (fiscal year 2002);
Eligibility verification process: Food Stamp applicants are asked to
provide documentary evidence of household assets, income, and allowable
deductions, as well as proof of noncitizen status. Allowable deductions
may include housing and utility expenses, medical expenses, and child
support payments. If documentary evidence is not available, state
agencies may use other means of verifying information provided by
applicants, including contacting third parties. State agencies are
required to verify certain information on income and deductions and
states may opt to require verification of additional information. State
agencies may establish their own standards for the use of verification
subject to the parameters specified in federal regulations.
Program: Housing and Urban Development rental assistance programs;
Overclaim rate[A]: 10.7 percent[I]; (fiscal year 2001); Administrative
cost: $945 million[J]; (fiscal year 2001); Eligibility verification
process: Applicants must provide third party verification of the
following factors: (1) family annual income, (2) value of assets, (3)
expenses related to deductions from annual income, and (4) other
factors that affect the determination of adjusted income. Housing
agencies may require documentation or they may verify self-reported
information by telephone. Individual housing agencies determine their
own verification procedures.
Program: Medicaid; Overclaim rate[A]: Not known; Administrative cost:
11.9 billion[K]; (fiscal year 2001); Eligibility verification process:
Medicaid provides health insurance coverage to certain low income
adults and children in a program jointly administered and funded by the
federal government and the states. While the Social Security
Administration sets the income threshold for Supplemental Security
Income-related Medicaid eligibility annually, most Medicaid
eligibility requirements and verification procedures are determined at
the state level and vary by state. For example, some states require
applicants to provide documentation of both income and allowable
deductions, such as child care expenses and child support payments.
Other states require applicants to provide information on income and
deductions but do not require further documentation. Federal law
requires that Medicaid applicants provide a Social Security number,
unless the applicant refuses to obtain a number because of well
established religious objections. While states are required to
establish procedures for the periodic redetermination of a recipient's
Medicaid eligibility at least annually, the procedures may vary by
state.
Program: Medicare; Overclaim rate[A]: 6.3 percent[L]; (fiscal year
2002); Administrative cost: 4.4 billion[M]; (fiscal year 2001);
Eligibility verification process: The Centers for Medicare and Medicaid
Services administers the Medicare program; however, the Social Security
Administration determines entitlement to Medicare benefits. Retired
recipients who are receiving retirement benefits from Social Security
or the Railroad Retirement Board are automatically enrolled in Medicare
the month they turn 65. Individuals who are under age 65 and disabled
are also automatically enrolled in Medicare after they have been
receiving Social Security or Railroad Retirement disability payments
for 24 months. All other individuals (e.g., retired individuals who are
not eligible for Social Security and individuals who have end stage
renal disease) are required to file a Medicare application at a Social
Security office.
Program: Temporary Assistance for Needy Families; Overclaim rate[A]:
Not yet Available; Administrative cost: $2.3 billion[N]; Eligibility
verification process: Eligibility requirements are determined at the
state or local level, and therefore vary by state and locality.
Source: GAO analysis of multiple agency data.
[A] See table 6 for information on how overclaim rates were calculated
for each program.
[B] IRS does not know the full cost of administering the EIC; for
example, the $145 million does not include the cost of processing EIC
returns.
[C] United States Department of Labor Benefit Accuracy Measurement
data.
[D] United States Department of Labor.
[E] Social Security Administration, Performance and Accountability
Report, fiscal year 2002.
[F] United States Department of Agriculture Food and Nutrition Service.
Includes state expenses for administering the School Breakfast Program,
the Child and Adult Care Food Program, and the Special Milk Program.
[G] United States Department of Agriculture Food and Nutrition Service,
Quality Control Division.
[H] United States Department of Agriculture Food and Nutrition Service.
[I] Housing and Urban Development's Audit of Financial Statements
Fiscal Year 2002 and 2001, 2003-Fiscal Year 2004 (January 31, 2001),
Note 17, p. 104ff.
[J] Departments of Veterans Affairs and Housing and Urban Development,
and Independent Agencies Appropriations for 2003, Hearings. 552-070-
28357-9, p.106.
[K] Health and Human Services' Financial Management Report, fiscal year
2001.
[L] Health and Human Services' Office of Inspector General, Improper
Fiscal Year 2002 Medicare Fee-For-Service Payments A-17-02-0220,
(January 2003).
[M] The Boards of Trustees, Federal Hospital Insurance and Federal
Supplementary Medical Insurance Trust Funds, 2003 Annual Report of the
Boards of Trustees of the Federal Hospital Insurance and Federal
Supplementary Medical Insurance Trust Funds. Administrative cost figure
includes administrative costs for both Federal Hospital Insurance and
Federal Supplementary Medical Insurance Trust Funds. Administrative
costs for Hospital Insurance include the costs of experiments and
demonstration projects as well as fraud and abuse control expenses.
[N] Health and Human Services' Administration for Children and
Families, Temporary Assistance for Needy Families Program Fifth Annual
Report to Congress. (February 2003).
[End of table]
To the extent known, how the overclaim rates are calculated, for the
nine benefits program we reviewed, including EIC, is shown in table 5.
Table 5: How Overclaim Rates Are Calculated for Selected Benefit
Programs:
Program: Earned Income Credit; How overclaim rates are calculated:
Compliance study based on audits of a statistically representative
sample of taxpayers and adjustments made to their tax returns.
Program: Unemployment Insurance; How overclaim rates are calculated:
The quality assurance system is used to estimate overpayments based on
a statistically valid sample of Unemployment Insurance claims from each
state. Investigators conduct detailed, comprehensive analyses of each
case by personally contacting employers, claimants, and third parties.
Investigators typically spend 5 to 8 hours examining each case.
Program: Supplemental Security Income; How overclaim rates are
calculated: The payment accuracy rate is based on a detailed analysis
of a sample of Supplemental Security Income cases. However, the Social
Security Administration's Office of Inspector General reported that not
all types of overpayments are counted as errors so payment accuracy
rates do not correspond to overpayments reported in the Social Security
Administration's financial statements.
Program: Social Security Disability Insurance; How overclaim rates are
calculated: The overpayment overclaim rate is based on a monthly sample
selection from the payment rolls consisting of beneficiaries in current
payment status. For each sampled case, the recipient or representative
payee is interviewed, collateral contacts are made as needed, and all
factors of eligibility are redeveloped as of the current sample month.
Program: School Lunch; How overclaim rates are calculated: The United
States Department of Agriculture does not routinely collect data on the
percentage of ineligible children receiving free or reduced price
school lunches.
Program: Food Stamps; How overclaim rates are calculated: Under the
food stamp quality control system, states draw a statistical sample,
review case information, and make home visits to determine whether
households were eligible for benefits and received the correct benefit
payment. Regional offices validate the results by reviewing a subset of
each state's overpayment and underpayment errors as necessary.
Program: Housing and Urban Development rental assistance programs; How
overclaim rates are calculated: The overclaim rate is based on an in-
depth analysis of a statistical sample of cases. The overclaim rate
showed an increase in 2001 over previous years largely because Housing
and Urban Development expanded its methodology for measuring error to
cover three types of program errors - incorrect reporting of income by
tenants; mistakes by public housing agencies, owners, and renting
agents in calculating income and rent amounts; and mistakes made by
public housing agencies, owners, and renting agents in completing
appropriate paperwork and billing Housing and Urban Development for
rental assistance.
Program: Medicaid; How overclaim rates are calculated: GAO has found
that few states measure the overall accuracy of their payments.[A].
Program: Medicare; How overclaim rates are calculated: This overclaim
rate for Medicare fee-for-service claims is based on a review of claims
conducted by the Housing and Human Service's Inspector General's
office. The Inspector General used a multistage stratified sample
design. For each claim, the provider was contacted and asked to provide
copies of all medical records supporting services billed. These records
were assessed to determine whether the services billed were reasonable,
adequately documented, medically necessary, and coded in accordance
with Medicare reimbursement rules and regulations. Billing practices
were also reviewed. Starting in fiscal year 2003, the Centers for
Medicare and Medicaid Services will publish a national overclaim rate
developed through the Comprehensive Error Rate Testing Program and the
Hospital Payment Monitoring Program. These programs build on the
Inspector General's methodology.
Program: Temporary Assistance for Needy Families; How overclaim rates
are calculated: Payment accuracy overclaim rates have not yet been
calculated for the Temporary Assistance for Needy Families' program.
Source: GAO analysis of multiple agency data.
[A] U.S. General Accounting Office State, Efforts to Control Improper
Payments Vary, G [Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-01-
662 ] AO-01-662 (Washington, DC: June 7, 2001).
[End of table]
[End of section]
Appendix III: Objectives, Scope, and Methodology:
Objectives:
We were asked to respond to 12 questions about IRS's certification
program, as shown in table 6.
Table 6: Questions We Were Asked:
1: What is the status of the EIC certification program, including the
timing and number/types of taxpayers to be contacted?.
2: Has IRS "tested" or conducted a "focus-group" of any related
letters, forms, or documents for understandability and other issues;
and, if so, what have been the results of such efforts?.
3: (a) What is the appropriateness of the draft certification forms and
explanations? (b) What are IRS's plans for processing them? (c) What
types of documents will EIC taxpayers need to provide the IRS? (d) Will
taxpayers generally be able to obtain the required documentation to
otherwise establish eligibility within the required time frame, such as
for marriage certificates, school transcripts, and rental agreements?.
4: What is the range of alternatives considered by IRS for obtaining
similarly reliable documentation, including the cost of alternatives,
and taking into account the cost of EIC noncompliance?.
5: What is the percentage of EIC claimants that would be required to
precertify prior to the 2004 filing season?.
6: What information does IRS have regarding differences in the EIC
overclaim rate among EIC claimants that are positively correlated with
filing status, relationship to the qualifying child, or other factors?.
7: To what extent are the issues of concern in GAO's report on the
current recertification program of similar concern in the new
certification program, including probable solutions to problem areas?.
8: Does GAO believe the certification program has been adequately
developed to prevent unreasonable burdens on EIC taxpayers and to
improve compliance?.
9: What is the current process for evaluating EIC eligibility?.
10: (a) What is the current EIC error rate? (b) Have recent statutory
changes had an impact on the error rate or on the rate of overpayments?
(c) Were these statutory changes for the purpose of deterring
noncompliance?.
11: What are the error rates of non-EIC taxpayer groups having
significant compliance issues?.
12: What are the error rates of comparable benefit programs
administered by states or the federal government and do these programs
use any verification process?.
Source: Subcommittee on Oversight, House Committe on Ways and Means.
[End of table]
In consultation with our requesters' offices, we grouped these
questions into three objectives, as follows: (1) describe the design
and basis for the EIC qualifying child certification program as
proposed by the EIC task force, (2) describe the current status of the
program, including significant changes since program approval, and (3)
assess whether the program is adequately developed to (a) prevent
unreasonable burdens on EIC taxpayers and (b) improve compliance so
that the test should proceed. In addition, we were asked to provide
readily available information on (1) significant noncompliance rates
other than for the EIC and (2) the overclaim rates and administrative
costs of comparable benefit programs administered by states or the
federal government and any verification process used by these programs.
Scope and Methodology:
To respond to all of the questions, we reviewed and analyzed relevant
IRS and other documentation, such as compliance reports, EIC task force
reports, draft letters and forms, testing and focus group records,
implementation plans, evaluation plans, and our prior products, and
interviewed Department of the Treasury and IRS officials involved in
the EIC certification program, including the Assistant to the
Commissioner; the National Taxpayer Advocate; Research, Analysis, and
Statistics officials; and members of the qualifying child certification
implementation team. We did not verify the accuracy of the data shown
in the various reports that we reviewed. Rather, we reviewed the steps
IRS had taken to implement the certification program and determined, to
the extent possible, how IRS ensured that the program had been
adequately developed to prevent unreasonable burden and improve
compliance. We did not evaluate whether IRS's preparations for
implementing the certification test, such as staffing and training,
were sufficiently developed to support proceeding with the test,
because they were outside the scope of our review, still under
development, or the Treasury Inspector General for Tax Administration
had audits planned.
The first objective includes, in order, our response to questions 10,
4, and 6. To determine the current EIC error rates and whether any
studies had been done on the impact of recent statutory changes on
error rates, we reviewed IRS's most recent compliance study, the
Treasury Inspector General for Tax Administration reports and our
previous reports, and interviewed IRS officials. In addition, we
reviewed the legislative history of recent statutory changes--effective
since 1999--that pertained to EIC. We analyzed these data and IRS and
Treasury reports to determine whether an analysis on the impact of the
legislative changes on EIC error or overclaim rates had been conducted.
To determine the range of alternatives considered by the task force, we
reviewed documents and interviewed members of the EIC task force. To
determine the correlation between overall EIC error rates, filing
status, and gender, we interviewed officials from Research, Analysis,
and Statistics and analyzed their data, and reviewed the EIC task force
reports and Treasury's past compliance studies.
The second objective included, in order, our response to questions one,
five, two, and seven. To determine the status of the EIC certification
program, including the number and types of taxpayers to be contacted,
we interviewed IRS and Treasury officials and reviewed documents
showing timelines and key milestones. We reviewed plans for the
certification program, such as IRS's Concept of Operations and the 2004
Increment Evaluation Plan, in conjunction with IRS's current process
for evaluating EIC eligibility. To calculate the percentage of EIC
claimants subject to certification in 2004, we divided the planned
sample size by the number of EIC claimants with qualifying children. To
obtain information on IRS's testing of letters, forms, and documents
for understandability, we observed the focus group testing that IRS
conducted in Dallas, Tex., with EIC taxpayers, tax preparers, and other
parties to understand how IRS assured itself that such persons
understood the forms and thought they could obtain the required
documentation. For whether items of concern we found within the
recertification program could have similar concerns in the new
initiative, we analyzed our prior reports on IRS's recertification
program and IRS's progress in implementing our recommendations, then we
compared our analysis to the certification plans.
The third objective includes, in order, our responses to questions
eight and three. To make our determination as to whether the program
had been adequately developed to improve compliance with minimal burden
to taxpayers, we asked IRS officials to describe and provide
documentation to support the steps they took to assure that the program
was adequately developed. This included interviews and a high-level
review of key steps and decisions found in various documents, such as
the EIC task force reports, the Concept of Operations, staffing plans,
training materials, and the evaluation plan. To determine the potential
extent of the burden on taxpayers, we reviewed reports from outside
groups that analyze programs and policies for low-income groups. We
obtained the opinions of IRS officials and discussed those of outside
stakeholders, such as representatives from the Annie E. Casey
Foundation, low income taxpayer clinics, and large tax preparation
organizations, that IRS had met with about any problems taxpayers might
have in complying with the documentation requirements to establish EIC
eligibility. We also interviewed IRS officials and reviewed EIC task
force documents to learn about the range of alternatives taxpayers have
available to obtain similarly reliable documentation, if they were
unable to comply with the certification documentation requirements.
Our responses to questions 11 and 12 are in appendixes I and II,
respectively. To determine the error rates of non-EIC taxpayer groups
having significant compliance issues, we reviewed compliance research
reports, interviewed officials about IRS's National Research Program,
and reviewed information contained in the Strategy and Program Plan. We
discussed our analysis with key IRS officials, including
representatives of the Assistant to the Commissioner. To determine the
overclaim rates, administrative costs, and verification process of
comparable benefit programs administered by states or the federal
government, we researched our prior reports and contacted our staff
knowledgeable about the selected programs. We selected nine programs to
review: Unemployment Insurance, Supplemental Security Income, Social
Security Disability Insurance, school lunch, food stamps, Housing and
Urban Development rental assistance, Medicaid and Medicare, and
Temporary Assistance for Needy Families. We chose these programs
largely because they were the same programs the EIC task force reviewed
and because each of them had some sort of precertification program. We
did not do a comprehensive analysis to determine which programs, if
any, were most comparable to the EIC, nor did we determine whether the
information reported for each program was consistent and could be
compared across programs. We did not do additional analyses to
determine how administrative costs compared to program outlays.
Our response to question nine is in the background section of this
report. To determine the current process for determining EIC
eligibility, we reviewed relevant IRS documents and our prior reports.
We verified the accuracy of this information in interviews with IRS
officials.
We conducted our work in Atlanta, Ga., Dallas, Tex., and Washington,
D.C., from May 2003 through September 2003 in accordance with generally
accepted government auditing standards.
:
[End of section]
Appendix IV: Key Milestones for the Qualifying Child Certification
Program:
Key milestones for the certification program for fiscal years 2002
through 2005, are shown in figure 4.
Figure 4: Key Milestones for the Certification Program:
[See PDF for image]
[End of figure]
[End of section]
Appendix V: Documents Related to the Precertification Program:
According to agency officials, IRS will send each of the 25,000
taxpayers subject to precertification four documents, including (1)
Notice 84-A, a letter informing taxpayers about the new program; (2)
Form 8836, "Qualifying Children Residency Statement;" (3) Publication
3211M, "Earned Income Tax Credit Question and Answers;" and (4)
Publication 4134, "Free/Nominal Cost Assistance Available for Low
Income Taxpayers." Copies of these documents, current as of September
2003, follow.
[See PDF for image]
[End of figure]
[End of section]
Appendix VI: Comments from the Internal Revenue Service:
DEPARTMENT OF THE TREASURY INTERNAL REVENUE SERVICE:
September 17, 2003:
Mr. Michael Brostek Director. Tax Issues Strategic Issues Team U.S.
General Accounting OH ice 441 G. Street, N W. Washington, DC 20548:
Dear Mr. Brostek:
I am pleased your report Earned Income Credit Qualifying Child
Certification Test Appears Justified, But Evaluation man is Incomplete
(GAO-03-794), recognizes the usefulness of our planned EITC
codification test. We have worked extremely hard to design the test and
to incorporate feedback from numerous stakeholders. I believe the test
will produce a large amount of useful information that will enable the
IRS to improve the way we administer the EITC program. Though your
point that our evaluation plan is a work in progress is accurate, I
believe this condition is to be expected at this point in our
implementation planning.
I am particularly pleased you identified some of the work the IRS has
done in developing the certification pilot, including:
* Designing the program to focus on known sources of noncompliance and
only those taxpayers whose qualifying child eligibility we cannot
verity from available information and on those taxpayers most likely to
make errors.
* Taking steps to address all of the concerns you have raised in your
review of the existing recertification program. In particular, we have
clarified the documentation requirements, developed a standard form,
expanded documentation options, and centralized certification
processing to help ensure consistent treatment of claimants.
* Attempting to minimize taxpayer burden and improve BEG compliance by
obtaining input from external and internal stakeholders that resulted
in changes that should reduce the burden on those eligible taxpayers
who are selected to certify.
* Undertaking more steps than usual to ensure the residency form and
other explanatory documents for the certification program have been
reviewed by those who would use them.
While the focus of your report is the certification pilot, the pilot is
only one part of an integrated 5-point initiative that also includes:
(1) reducing the backlog of pending EITC examinations to ensure that
eligible taxpayers receive their refunds quickly, (2) reviewing the
existing audit process to minimize the burden on taxpayers and improve
the quality of communications with taxpayers, including notices, (3)
increasing outreach efforts to encourage more eligible taxpayers to
claim the EITC and to ensure that the requirements for claiming the
credit are clearly understood, and (4) enhancing compliance efforts
toward taxpayers who claim the credit but are ineligible because their
income is too high. This last item includes the filing status and,
income misreporting proposals that, along with qualifying child
certification, comprised a holistic approach to address the three major
sources of EITC non-compliance.
Recommendation that the Commissioner of Internal Revenue accelerate the
development of IRS's plans to evaluate the certification test. You
correctly observe that we have adequate but limited time to finalize
the plan. We have considered the components you have suggested are
needed for a robust plan. We are working to bring those components
together well before the certification pilot begins in January 2004. We
will make sure that the objectives of the evaluation plan are clearly
articulated, that all necessary data and perspectives are captured, and
that all explicit assignments and timeframes are established for the
completion of the components of the evaluation.
To provide a more complete picture of the evaluation plan efforts made
to date, we have included an enclosure that contains a description of
additional evaluation plan information that was not included in your
report.
We will also incorporate, where appropriate, your suggestions and the
suggestions of the third party that will be independently reviewing the
evaluation plan. Mark Mazur, Director, Research, Analysis and
Statistics, is the IRS official responsible for the evaluation plan.
Finally, we have one comment on Appendix I, which lists five types of
misreported income estimated by the IRS for 1992. You compare these
figures to estimates of EITC non-compliance for 1999. We note, however,
that the percentage of EITC non-compliance presented in the 1999
Compliance Study is not comparable to the percentages of misreported
income listed in Appendix I. The EITC overclaim rate is the dollar
amount erroneously paid divided by the dollar amount actually paid. In
contrast, the estimated non-compliance percentages listed in Appendix I
are net misreporting percentages, defined as the net amount of income
erroneously reported divided by the total amount of income
that should have been reported. Therefore, these figures are not
strictly comparable.
If you have any questions, or if you would like to discuss this
response in more detail, please contact David R. Williams, who was
recently designated to lead this critically important integrated EITC
initiative, at (202) 622-5440.
Sincerely,
Mark W. Everson:
Signed by Mark W. Everson:
Enclosure:
Additional Program Evaluation Planning Activities Not Discussed in the
GAO Draft Report:
The IRS draft evaluation plan provides a framework for both a
quantitative analysis of what the selected claimants experience
throughout the certification process and a qualitative analysis of
whythey have those experiences. The IRS will perform the quantitative
analysis using data that it will collect throughout the certification
pilot, and a third-party contractor will perform the qualitative
analysis through surveys. The IRS continues to refine the evaluation
framework to reflect modifications to the certification pilot and to
provide greater detail about the execution of the evaluation plan. The
GAO discussion of the evaluation framework is essentially accurate, but
it does not include important information about the planning that has
already occurred and continues to occur that will result in the
specificity that IRS and GAO agree are needed before the certification
process test commences in January 2004.
The GAO states that the draft evaluation plan identifies a threshold
question of "whether the claimant selected for the test provided the
required information to allow IRS to determine the eligibility of the
qualifying children regardless of whether the claimant was determined
eligible or not." The GAO seems to agree that the IRS sufficiently
developed an evaluation plan to answer that question.
The GAO, however, does not include the information that the IRS will
capture to address this and numerous other relevant questions. This
information includes:
* Claimant characteristics:
* Qualifying child eligibility:
* Point in time when a claimant attempts to certify:
* Number of times a claimant attempts to certify:
* Iterations to successfully certify:
* Reasons for iterations:
* Time elapsed from receipt of claimant certification information to IRS
eligibility determinaiton:
* Documentation submitted by the claimant to certify:
* Ability to successfully certify:
The evaluation plan explains that this information will be available on
an on-going basis, but that statistically precise information will not
be available until the selected taxpayers' residency eligibility is
finally determined. The plan also provides for analysis of the data to
be produced approximately every two months. Thus, information will be
available at the end of March for those taxpayers who file early and by
the end of May for those taxpayers who filed at any point in the filing
season.
The plan also states that IRS will analyze data about selected
taxpayers who have not responded to the certification notice. The IRS
analysis will include data to discern whether the claimant had a filing
requirement and whether EITC eligibility or ineligibility is apparent
from available IRS information.
The GAO states that the IRS must answer additional questions, beyond
the threshold question, to determine whether residency certification
reduces EITC overclaims, specifically: (1) why a taxpayer does not
attempt to certify or why he or she is unable to do so and (2) how
burdensome is the certification requirement. We believe the plan and
corresponding data that the IRS intends to capture will provide the
information to address these and other relevant questions.
As GAO acknowledges, the IRS will:
* Compare the experiences of the taxpayers selected for certification to
a control group of taxpayers (with similar characteristics to the
certification pilot group):
* Evaluate all available data to discern information about those
claimants who do not attempt to certify or chose not to claim EITC.
* Use a third-party to gather information through a survey of a sample
of taxpayers selected for certification (including both taxpayers who
attempt to certify and those who do not) to understand why taxpayers
are unwilling or unable to certify and to determine the burden imposed
by the certification process.
The IRS has prepared a draft survey plan as an aid to the third-party
contractor, who would conduct the survey. This plan includes over 40
questions, including specific questions about why taxpayers did or did
not certify; the cost, time, money and difficulty involved in obtaining
documentation; and the availability of IRS and other assistance. As we
have explained to GAO, we cannot actually contract for the survey until
we know funds will be available for this purpose in the FY04 budget.
The evaluation plan provides for the IRS to collect data in July or
August 2004 for those claimants who fail to certify and fail to claim
EITC. In addition, the draft survey plan likewise discusses when the
third-party would contact taxpayers. Specifically, the survey plan
states that the contractor could begin surveying some claimants as soon
as their returns have been processed and certification determinations
made. It also recognizes that some surveys cannot begin until after the
filing season. Because taxpayers can submit their documentation
throughout the filing season, we will not know until after the filing
season ends whether a taxpayer has been unwilling or unable to certify.
Similarly, a taxpayer who delays certification until the end of the
filing season will not be able to discuss how burdensome the process
was until after he or she has actually undergone that process.
We have refined the certification pilot in response to internal and
external stakeholder comments. We are also refining the evaluation
plans to ensure they reflect the changes to the certification pilot.
This will, of course, include modifications to the data being captured
and the schedule for the analyses. We advised GAO that, in response to
public comments, we have arranged to have an independent third party
review the evaluation plan (including the sample selection) to ensure
that the pilot and evaluation will allow us to effectively assess the
residency certification process. This third-party review will be
similar in scope to third-party review of the National Research
Program.
[End of section]
Appendix VII: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Michael Brostek (202) 512-9110 Joanna Stamatiades (404) 679-1984:
Acknowledgments:
In addition to those named above, Tiffany Brown, Evan Gilman, Veronica
Mayhand, Kathryn Larin, David Lewis, Donna Miller, Libby Mixon, Cheryl
Peterson, and Tom Short made key contributions to this report.
(450216):
FOOTNOTES
[1] Overclaim rates are calculated based on erroneous claim amounts
less any amounts IRS recovered or expects to recover, such as through
examinations. IRS also has limited information on underclaim rates, or
instances in which taxpayers claimed less than they were entitled to
receive. This report primarily focuses on IRS's efforts to address
noncompliance related to overclaims using the qualifying child
certification program.
[2] The program discussed in this report is one part of a strategy to
target three major known sources of EIC noncompliance. The other two
parts involve the improper reporting of filing status, such as among
married taxpayers who report as single or head of household to avoid
reporting their spouse's income, and income misreporting, such as
underreporting earned income.
[3] Taxpayers must meet multiple criteria in order to claim the EIC, as
shown in table 1. Residence is one criterion for a taxpayer with a
qualifying child.
[4] 26 U.S.C. Sec. 32.
[5] Underclaims refers to the amount in which taxpayers claimed less
than what they were entitled to receive.
[6] Prior to 2001, EIC was part of a broader IRS tax filing fraud high-
risk area. Beginning in 2001, the focus of that designation was
narrowed to EIC specifically. U.S. General Accounting Office, High-Risk
Series: An Update, GAO-01-263 (Washington, D.C.: January 2001).
[7] Taxpayers are required to meet recertification requirements when
they have been denied the EIC in a previous year. Recertification
involves taxpayers providing documentation, such as a birth
certificate, to support their claim of a relationship to a qualifying
child.
[8] U.S. General Accounting Office, Earned Income Tax Credit
Participation, GAO-02-290R (Washington, D.C.: Dec. 14, 2001).
[9] The new AGI tiebreaker rule applies when two taxpayers can claim
the same qualifying child. If one of the taxpayers claiming the credit
is the child's parent (or parents who file a joint return), then the
child is considered the qualifying child of the parent or parents. If
both parents claim the child and parents do not file a joint return,
then the child is considered a qualifying child first of the parent
with whom the child resided for the longest period during the year, and
second of the parent with the highest adjusted gross income. If none of
the taxpayers claiming the child as qualifying is the child's parent,
the child is considered a qualifying child with respect to the taxpayer
with the highest adjusted gross income.
[10] In addition to the $250 million that IRS requested in its fiscal
year 2004 budget request to administer the EIC, IRS incurs some
additional costs. For example, IRS incurs costs to process the EIC tax
returns. Therefore, the full cost of administering the EIC is not
known.
[11] Improper filing status claims and income misreporting are other
common problems associated with the EIC. IRS plans to verify the filing
status for about 41,650 cases in fiscal year 2004, but the criteria for
selecting the cases have not yet been finally determined. In fiscal
year 2004, IRS plans to use document matching to verify the income
reported by about 300,000 EIC filers who have a history of misreporting
income for 2 consecutive years in order to increase (or receive) the
EIC. Depending on how well these efforts work in fiscal year 2004, they
would be expanded in future years. Also see U.S. General Accounting
Office, May 20 Oversight Hearing on the Internal Revenue Service -
Questions for the Record, GAO-03-962R (Washington, D.C.: June 27,
2003).
[12] For 2002 returns, taxpayers who claim the EIC with a qualifying
child must meet certain tests, including residency and relationship. To
meet the residency test, the qualifying child had to live with the
taxpayer in the United States for more than half of the year. To meet
the relationship test, the qualifying child had to be a son, daughter,
adopted child, stepchild of the taxpayer, or a descendent of any such
individual. Sisters, brothers, stepsisters, stepbrothers, and
descendents of any such individual also qualify if the taxpayer cares
for the individual as they would their own child. In addition, a foster
child can qualify for the relationship test if certain conditions are
met. Internal Revenue Service, Earned Income Credit (EIC), Publication
596 (Washington, D.C.: 2002).
[13] Andrew J. Cherlin and Paula Fomby, "Welfare, Children, and
Families: A Three-City Study," A Closer Look at Changes in Children's
Living Arrangements in Low-Income Families, Working Paper 02-
01(Baltimore, MD.: Johns Hopkins University, Feb. 20, 2002), and Allen
Dupree and Wendell Primus, Declining Share of Children Lived with
Single Mothers in the Late 1990s: Substantial Difference by Race and
Income (Washington, D.C.: Center on Budget and Policy Priorities, June
15, 2001). We did not review these studies in detail. Instead, we
relied upon IRS's assessment.
[14] The "certification" program is different from the IRS
"recertification" program, which is required by statute.
Recertification was implemented in 1998 and requires taxpayers who have
been disallowed the EIC through an IRS examination to substantiate
their qualification for the EIC, i.e., recertify before they receive
the credit again. U.S. General Accounting Office, Opportunities to Make
Recertification Program Less Confusing and More Consistent, GAO-02-449
(Washington, D.C.: Apr. 25, 2002).
[15] IRS will exclude from its sample taxpayers who are subject to an
examination, investigation, or other treatment at the same time.
[16] The Stakeholder Partnership, Education, and Communication
Organization is a unit with IRS's Wage and Investment operating
division. Its role is to educate and assist taxpayers before their
returns are filed.
[17] Before the focus groups commenced, IRS had decided to move forward
only with the residency certification.
[18] According to IRS officials, approval from the Office of Management
and Budget is required in situations where the agency conducts
interviews with more than nine private sector participants. However,
because conducting such interviews was suggested later in the process
and because OMB had been briefed on the development of the
certification test, IRS did not seek that approval.
[19] GAO-02-449.
[20] IRS generally tests few forms and instructions with taxpayers
before using them. See U.S. General Accounting Office, Tax
Administration: IRS Should Reassess the Level of Resources for Testing
Forms and Instructions, GAO-03-486 (Washington, D.C.: Apr. 11, 2003).
[21] GAO-02-449.
[22] See Internal Revenue Manual 1.1.4 and 1.2.1.
[23] IRS's draft evaluation plan preceded its decision to test
certification during the 2004 filing season. These data will now need
to be collected during the filing season.
[24] For almost 30 years, the Taxpayer Compliance Measurement Program
was IRS's method for statistically estimating the voluntary compliance
of taxpayers in reporting their tax obligations.
[25] Among other things, IRS plans to use NRP data to update the
formulas used to select tax returns for examination and allow it to
design programs that will help taxpayers comply with tax laws.
[26] Personnel in IRS's Wage and Investment operating division conduct
the majority of EIC examinations.
[27] We use the term overclaim rate to be the total excess payments
made in error. This is generally referred to as the error or
overpayment rate in the other programs we reviewed.
[28] See, for example, U.S. General Accounting Office, School Meal
Programs: Estimated Costs for Three Administrative Processes at
Selected Locations, GAO-02-944 (Washington, D.C.: Sept. 25, 2002).
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