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Friday, March 4, 2011

Weathering the EIC Controversy

Beleaguered by controversy, the Earned Income Tax Credit (EIC or EITC) has been the bane of many a preparer’s existence, in part because of the due diligence requirements.  Many people see it as a way to dramatically assist low-income taxpayers, others as a great way to scam the government for a higher tax refund, and some as an excellent opportunity for tax fraud.

Originally enacted in 1975 by the Tax Reduction Act, EIC was designed to offset the impact of payroll taxes on low-income workers and to encourage such persons, who might otherwise receive welfare benefits, to seek employment.

Because the credit is refundable, even if taxpayers have no tax liability, the IRS will refund the amount of EIC. Studies show that the credit has been successful in encouraging single parents to leave welfare for work and in supplementing the earnings of minimum-wage workers.

At the same time, according to a recent study conducted by TIGTA (Treasury Inspector General for Tax Administration), in 2009 alone over 24 million taxpayers received $55 billion in EIC dollars.  The study also states 23 to 28 percent of EIC payments are improperly issued each year.

EIC was expanded by the American Recovery and Reinvestment Act of 2009 (ARRA) to include a third tier of EIC for families with three or more children, recognizing that larger families may face a higher cost of living and be more likely to be listed among the working poor. By contrast the credit for workers without children remains extremely small, almost too small to offset federal taxes for workers at the poverty line. 

Rules for eligibility have expanded over the years to include requirements for adjusted gross income and earned income levels, age limits, and investment income levels.  Adding to the confusion is the dilemma caused by new rules defining a qualifying child or relative.

Checklists such as Publication 3524, the EITC Eligibility Checklist, have become necessary in order to wade through all the eligibility factors. Tie breaker rules become extremely important when a child could be the qualifying child of more than one taxpayer.

While studies show that the credit has had tremendous success, fraud has also become a prevailing factor. Some of the most frequent scams include multiple returns for the same individuals, phony Social Security numbers, identity theft, and claims of non-existent children or spouses. According to the Government Accountability Office, of all federal programs, EIC maintains the second highest dollar amount of improper payments.

To mitigate abuse the IRS has instituted checks, such as Form 8867, EITC Due Diligence Requirements.  Preparers are subjected to IRS audits for EIC due diligence, especially those who prepare a high volume of EIC returns.  Preparers must evaluate information received from taxpayers then document and retain records of inquiries and responses.  Preparers who do not meet due diligence requirements are faced with penalty assessments.

The IRS may reduce or deny EIC upon audit of the taxpayer’s return. Taxpayers who are found to have made an error due to reckless or intentional disregard of EIC rules cannot claim it for the next two years; if fraud is involved, the EIC cannot be claimed for the next ten years.

To improve EIC administration, in 2008 the IRS conducted a study on EIC and considered implementing qualifying child residency certification processes; in the end the IRS decided not to do so.  They did identify a particular set of issues broadly defined as identity theft, where individuals were using IDs that did not belong to them.

In the current economy I can understand why low-income workers have great need of EIC; their financial situation does not include capacity to withstand tough winter weather and loss of employment.  At the same time I can see how some taxpayers are viewed as using EIC as cause to work less to get more. 

Pushed by TIGTA to institute better methods of protection against fraudulent EIC claims, I can also see IRS requesting the passage of even more regulations, perhaps with stricter guidelines, in turn creating more due diligence requirements for preparers.

For more information about the Earned Income Tax Credit refer to

v     Publication 596, Earned Income Credit,
v     Publication 3524, Earned Income Tax Credit Checklist, and
v     The EITC Home Page at IRS, http://www.irs.gov/individuals/article/0,,id=96406,00.html.
v     TIGTA Report Reference Number 2011-40-023.