The Internal Revenue Service disallowed nearly $1.6 billion in erroneous First-Time Homebuyer Tax Credits, but could have flagged even more, according to a new government report.

J. Russell George

The report, from the Treasury Inspector General for Tax Administration, found that as of July 30, 2011, the IRS had processed more than 4.3 million claims for the homebuyer credit totaling almost $30.4 billion. Qualified taxpayers who purchased a home in 2008, 2009 or 2010 were able to take advantage of the homebuyer credit and claim up to an $8,000 refundable credit on their tax return. The homebuyer credit can function as an interest-free loan or a fully refundable tax credit, depending on when taxpayers purchased their homes.

TIGTA conducted the review because an earlier audit in September 2009  found that control weaknesses at the IRS were allowing taxpayers who most likely did not qualify for the homebuyer credit to receive potentially erroneous refunds, including minors. TIGTA wanted to determine whether the IRS has been adequately addressing questionable claims for the homebuyer credit since that earlier report was issued.

TIGTA found that while the IRS completed 495,592 homebuyer credit examinations, a large number of high-risk claims were not examined. In addition, many of the examinations conducted were unproductive.

Specifically, the IRS never ran some of the high-risk claims through its automated filters, which were designed to select claims for examination. The IRS’s methods for determining the highest-risk claims were also flawed, according to TIGTA.

During the course of the audit, though, TIGTA made recommendations that resulted in immediate IRS corrective actions. IRS management not only modified their methods of determining high-risk claims, they also shifted their examination resources to more productive cases.

“The purpose of these examinations is to ensure that only qualified taxpayers receive the Homebuyer Credit,” said TIGTA Inspector General J. Russell George in a statement. “Examining homebuyer credit claims that pose the greatest compliance risk is an effective use of limited IRS resources and avoids burdening compliant taxpayers with an examination.”

TIGTA also found that, in some instances, the IRS’s use of post-processing math error authority to disallow homebuyer credits that had previously been allowed denied specific rights to taxpayers that had been associated with the IRS’s deficiency processes. The IRS agreed with TIGTA’s findings and took steps to address the issue.

The Worker, Homeownership, and Business Assistance Act of 2009 extended the homebuyer tax credit and provided the IRS with tools to significantly enhance the agency’s ability to assess the validity of First-Time Homebuyer Tax Credit claims during processing and stop those that were found to be ineligible, the IRS noted in its response to the TIGTA report. “Primarily, a requirement was placed on taxpayers claiming the credit to provide documentary evidence of the home purchase, such as the closing or settlement statement,” wrote Peggy Bogadi, the commissioner of the IRS’s Wage and Investment Division. “The IRS was also given math error authority to deny the credit when documentation was missing or insufficient, or the taxpayer was found to be otherwise ineligible for claiming the credit. This allowed us at the time of processing, to detect and correct more erroneous claims and avoid diverting them for examination review. As with any new process, valuable lessons were learned as we implemented and refined our strategy for detecting and addressing questionable claims.”

TIGTA recommended that the IRS use updated examination results to make adjustments throughout the year. That would optimize the overall examination results, according to TIGTA, and ensure that all claims for the homebuyer credit are run against IRS automated examination filters so the highest risk cases would be selected for post-refund examinations.

The IRS agreed with TIGTA’s recommendations, but disagreed with one of the outcome measures discussed in the report. TIGTA contended, however, that the IRS did not consider pertinent data regarding its high percentage of no-change cases for pre-refund homebuyer credit examinations.