On January 28, the IRS announced, unexpectedly, that processing returns with Form 8863, Education Credits, would be delayed until mid-February. Thousands of returns with Form 8863 had already been processed as a part of the IRS's preseason live system testing, and thousands more were already in the queue. This resulted in a lot of confusion for taxpayers and tax preparers, leaving many wondering when refunds would be processed for those returns already in the pipeline.
When the IRS made this surprising announcement at the end of January, it stated, "The IRS discovered during testing that programming modifications are needed to accurately process Form 8863." This general statement left a lot of room for speculation. The IRS certainly noticed a not-so-good trend, but was that trend related to "technical" processing issues, or, did the early fraud and ID theft detection systems expose significant fraudulent claims in the form of Education Credits? The IRS never mentioned the word "fraud;" however, the American Opportunity Tax Credit (AOTC) is partially refundable, and fraudsters like to target refundable credits. With Form 4136, Credit for Federal Tax Paid on Fuels, sidelined indefinitely due to late legislation (another refundable credit susceptible to fraud), the refundable AOTC became an even more likely target.
Interestingly enough, Form 8863 received a makeover this year. I'm sure you've noticed the form requires a lot more supporting information - an attempt by the IRS to better validate the claim in light of a startling statistic that was identified last year: 109,618 taxpayers received refundable AOTC for Tax Year 2011 totaling more than $159 million for students who were of an age that made them unlikely to be enrolled in a four-year college degree program*. Yikes! So that explains why details must now be included for each educational institution to which qualified expenses were paid. (This is similar to what some states, such as Kentucky, New York, and Michigan, have been requiring for their corresponding tuition credits.) This additional information surely would have made it easier for the IRS to spot patterns in fraudulent AOTC claims.
Outside of the speculation, what we do know is that funding (refund processing) for early returns with Form 8863 is virtually non-existent**. (See the chart below.) The funding rate for returns with Form 8863 is exactly zero from January 27 - February 14. From February 14 on, the funding rate for returns with Form 8863 corresponds precisely to the overall funding rate.
Bottom line: something was up. The IRS may provide more details in the future, but for now, we can only speculate.
* - Statistic pulled from the 2012 Filing Season Report prepared by Treasury Inspector General for Tax Administration (TIGDA)
** - The data, extracted on 2/21/2013, is based on a sample and does not include all returns from all sources.