IRS Releases More Detail on EITC Over-Payments

One of the major issues with the Earned Income Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. is that is suffers from a high amount of payment error. In any given year, the error can amount to approximately 25% of total payments and cost $14 billion dollars.

It is usually not clear exactly why these errors occur. There are two common stories behind them. The first story is about plain fraud. Taxpayers, or the preparers that help them file taxes, are purposefully misrepresenting their information in order to receive the EITC, or increase their EITC.

The second story is that EITC filers, which are typically lower-income individuals with lower levels of education, are making a high number of mistakes when filing. For instance, they may claim their child as a dependent (which leads to a much larger EITC), but their ex-spouse may have claimed their child as well. The result being that one parent is non-compliant.

Recently, the IRS released an update to a study it did in 1999 on the EITC and source of its high errors. The 2006-2008 EITC compliance study uses taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. auditA tax audit is when the Internal Revenue Service (IRS) conducts a formal investigation of financial information to verify an individual or corporation has accurately reported and paid their taxes. Selection can be at random, or due to unusual deductions or income reported on a tax return. data to study the source of EITC non-compliance. While it doesn’t really answer the above questions about whether errors are fraud or mistakes, it has a few important data points that we should keep in mind.

Most Errors were Income Misreporting, but Most Dollars were Qualifying Child Errors

The most common error was income misreporting. This represented 58 percent of total errors. However, since these errors averaged around $800, this type of error only accounted for 35% of total error dollars.

The second more common error was claiming a child when the taxpayer shouldn’t. Although this only accounted for 21 percent of the total number of errors, it accounted for 38 percent of the total cost. This is due to the fact that claiming a child in error resulted in an average error size of $2,384. This makes sense, given the structure of the EITC, which increases its value greatly for each child a taxpayer has.

Only 9 percent of those who claimed the EITC in error had both types of errors. These errors had the highest average value at $2,451. The remaining 12 percent of errors include issues like filing status errors and invalid social security numbers and averaged about $1,447.

Those Who Claim the EITC Were More Likely to have Someone Else Prepare Their Tax Return

An important thing to keep in mind about those who claim the EITC is that they prepare their tax returns in a systematically different way than taxpayers who don’t. Specifically, they are far more likely to have others (paid preparers or free preparers) fill out their tax return for them. According to the IRS report, 68 percent of those claiming the EITC had someone else prepare their tax return for them. This is compared to the 55 percent of taxpayers who did not claim the EITC who used a preparer.

The type of preparer used differed between those who claimed the EITC and those who didn’t. The biggest difference is the use of CPAs vs. the use of National Tax Preparation Firms and Unenrolled Preparers. According to the IRS, 16 percent of those who did not claim the EITC used a CPA, while only 6 percent of those claiming the EITC did so. In contrast, 21 percent and 26 percent of those who claimed EITC used either a national tax preparation firm or an unenrolled preparer, respectively. This may be due to price (CPAs may cost more), or availability (national tax preparation firms may be located in more low-income areas compared to CPAs).

Regardless of Preparer Type, Error Rates are High

The report also showed the likelihood of EITC over claims by preparer type. The biggest takeaway is the fact that there is not statistically significant difference in the likelihood of over reporting between self-preparers and paid preparers. 47 percent of self-prepared returns over-claimed the EITC compared to 51 percent of paid preparer returns.

It should also be noted that some of these subtypes of preparers, especially IRS paid preparers, attorneys, and employees of taxpayer have a very low sample sizes (only 3 percent of all returns claiming the EITC were prepared by the IRS). The fact that IRS preparers and friends have the lowest error rates may be due to chance, rather than for any systematic reasons.

Overall, the report found that between 43 and 50 percent of all returns had an error in favor of a higher EITC payment between 2006 and 2008. This represents an over claim dollar amount of about 28 to 39 percent.