EIC verification initiative.

To address earned income tax credit (EIC) overclaims, the IRS is proposing to precertify 45,000 EIC recipients beginning in July 2003 and another two million taxpayers starting in 2004. Although the details of the precertification program are vague, the Service plans to use a combination of taxpayer education and enforcement to reduce EIC overclaims.

According to John M. Dalrymple, Commissioner of the IRS's Wage and Investment Division, the EIC overclaim rate has reached $9.9 billion or 31.7% of EIC benefits, based on a Treasury study of 1999 returns. The Service's precertification plan appears to be aimed only at EIC overclaims and does not attempt to bring the estimated 4.3 million taxpayers eligible for the EIC--but who fail to claim the credit--into the tax system.

According to IRS statistic's, approximately 19 million taxpayers claim the EIC, and more than 70% use a return preparer. EIC overclaims are a result of intentional taxpayer fraud and unintentional taxpayer errors caused by the multiple complexities of claiming the EIC. The Service identified three specific problem areas--ineligible qualifying children, incorrect filing status and underreported income--as the source of 80% of EIC overclaims.

How It Works

Under the EIC precertification initiative, the IRS is precertifying only specific aspects of EIC eligibility--the relationship and residency status of qualifying children. Thus, a taxpayer could later be denied an EIC for failing another eligibility requirement (e.g., income) that is not being precertified. In the trial phase, the Service will select EIC recipients who are deemed "high error" EIC filers. These taxpayers will have until December 2003 to submit proof of relationship and residency for their qualifying children. The IRS has identified affidavits from a variety of sources (e.g., clergy, day-care providers, school officials and social service agencies) as acceptable documentation; thus, the burden of precertification will extend beyond the taxpayer.

The proof-of-residency requirement will become an annual event for EIC claimants whom the Service classifies as being in the EIC high-error category. However, married taxpayers who file jointly or mothers who file as single or head-of-household will be exempt from the annual precertification filing requirements. To implement the EIC precertification program, President Bush's fiscal 2004 budget targets $100 million and an additional 650 IRS staff.

Program Wrinkles 

On April 8, 2003, the House Ways and Means Oversight Committee asked the General Accounting Office to examine the IRS's plans for EIC precertification, citing fears of significant taxpayer burden compared to other Federal programs for low-income taxpayers (such as food stamps). The Oversight Committee also expressed concerns that the Service is not allowing sufficient time to examine the results of the EIC precertification of 45,000 taxpayers planned for 2003, before broadening the precertification scope in 2004.

Although the specific details of the precertification program have not been disclosed, the program has tremendous potential to cause confusion and panic among uncontacted EIC recipients, resulting in increased inquiries to the IRS and other tax professionals. Taxpayers may not understand why a relative or neighbor is being precertified for EIC, and they are not. Because only a portion of the taxpayer's EIC eligibility is being precertified, it is unknown the type of assurance letters taxpayers will receive, and the recourse they will have if precertification is denied. It is also unclear how the Service will assure consistent treatment of taxpayers and their precertification documentation.

The taxpayer's financial burden associated with EIC precertification is another major concern. The cost of assistance from a CPA or other tax professional could substantially dilute the anti-poverty effects of EIC funds. Whether states with the EIC will accept any of the IRS precertification documentation in their audit process is unknown.

EIC overclaim rates are high because taxpayers self-report their eligibility; EIC benefits represent one third or more of a taxpayer's annual income, and the rules are complex. In the coming months, Congress and the Service will sort out whether an EIC precertification role is appropriate for the ILLS. The CPA profession and IRS-funded (Sec. 7526) low-income taxpayer clinics will also need to identify the role that they can play in the proposed EIC precertification program, in identifying alternative solutions to reducing EIC errors and in encouraging eligible EIC nonfilers to file tax returns.

FROM CHRISTINE C. BAUMAN, PH.D., CPA, DIRECTOR--LOW INCOME TAXPAYER CLINIC, UNIVERSITY OF WISCONSIN--MILWAUKEE, MILWAUKEE, WI

Mark H. Ely, J.D., CPA

Partner

Washington National Tax

KPMG LLP 

Washington, DC