IRS tightening filters to screen refundable tax credits for fraud

The Internal Revenue Service has updated its systems to detect invalid claims for the Child and Dependent Care Credit and the Earned Income Tax Credit to guard against errors and scams next tax season.

A report released last week by the Treasury Inspector General for Tax Administration reported on the IRS’s efforts to ensure claims for the expanded CDCC and the self-only EITC under the American Rescue Plan Act of 2021 were valid. The changes made the CDCC one of the largest refundable tax credits administered by the IRS for tax year 2021. 

The expansion made the CDCC fully refundable for taxpayers whose main home was in the U.S. for more than half the year. The maximum amount of credit also increased from $1,050 to $4,000 for one qualifying person and from $2,100 to $8,000 for two or more qualifying persons. Taxpayers claim the CDCC by filing Form 2441, “Child and Dependent Care Expenses.” The form requires taxpayers to enter information about their care provider, including the name, address, Taxpayer Identification Number and the amount paid. The American Rescue Plan Act also temporarily expanded the eligibility rules and the amount of EITC for “self-only” taxpayers with no qualifying children for tax year 2021. 

“Refundable credits present a unique risk to tax administration because taxpayers not only can have their tax reduced to zero; they can also receive a ‘refund’ of excess credit,” said the report. “The unintended consequences of refundable credits are that they can result in the issuance of improper payments and can be the target of unscrupulous individuals. As such, they pose a significant risk as an avenue for those seeking to defraud the government.”

TIGTA audited the program last year and found several ways that the IRS needed to improve its business rules to screen out invalid claims. In response, the service created three new business rules and revised seven of its rules. For the three rules implemented after TIGTA brought these concerns to management’s attention, the IRS found that 932 taxpayers had more than $2.2 million in CDCC claims rejected before the return was accepted. 

TIGTA said the service still needs to take further action, though, to address its previous recommendations. Its review of tax returns filed as of May 5, 2022, continued to identify 3,573 returns with potentially erroneous CDCCs totaling $6.8 million with obviously invalid care provider Taxpayer Identification Numbers. 

On top of that, TIGTA found that taxpayers who have Social Security Numbers not eligible for work continued to receive erroneous EITCs. As of May 5, 2022, there were a total of 7,486 electronically filed tax returns identified by the IRS’s pre-refund filters that didn’t meet the requirements for the self-only EITC. 

If the IRS had the appropriate legal authority, the agency could reject these returns without creating any legal risk and prevent more than $2.9 million in improper payments, the report noted, but it has to wait for Congress to give it that authority. 

The report also found that CDCCs were allowed that exceeded the statutory limits allowed by law due to employee errors and a lack of controls. TIGTA identified 61 tax returns that received a total of $203,535 more in refundable CDCC claims than allowed by the law. 

TIGTA made nine recommendations to the IRS, including that it update its programming this year to identify taxpayers who reported an obviously invalid care provider Taxpayer Identification Number on the Form 2441. 

TIGTA also recommended that the IRS work with the Treasury Department’s Office of Tax Policy to advance legislation to treat a tax return as filed only when it is accepted, allowing the IRS to remove the legal risk of rejecting tax returns. 

The IRS agreed with seven of TIGTA’s recommendations, but disagreed with two. Agency officials did not agree to develop a tool or programming to ensure tax returns with prior-year expenses are systemically identified. The IRS also didn’t agree to review the 774,559 returns TIGTA identified that received more than $668.8 million in self-only EITC refunds from potentially ineligible claims, and to recover credits that are determined to be erroneous.

“The IRS has a robust audit selection process, which considers many factors to balance our resources across all compliance areas,” the IRS responded. “The returns identified are subject to selection for examination as resources allow.”

The vast majority of the claims for the expanded tax credits were handled the right way, the IRS pointed out. “We note that the review shows that 99.94% of the tax year 2021 claims were processed correctly,” wrote Kenneth Corbin, commissioner of the IRS’s Wage and Investment Division, in response to the report. “Similarly, of 5.5 million returns claiming CDCC that were reviewed, 99.99% were processed correctly.”