The Internal Revenue Service does not always identify potentially mistaken claims for General Business Credits when processing tax returns, according to a new government report that found unsupported claims for the credits totaling $1.3 billion for 2011.

The report, released Wednesday by the Treasury Inspector General for Tax Administration, reviewed tax returns for tax year 2011 with claims for General Business Credits and found that the IRS has not established effective processes to identify individuals who claimed potentially erroneous General Business Credits at the time the IRS processed their returns.

In tax year 2011, the IRS received 455,618 individual income tax returns with General Business Credits offsetting the taxes owed by more than $2 billion. However, TIGTA found 8,657 electronically filed tax returns for tax year 2011 with unsupported and potentially erroneous claims for General Business Credits totaling approximately $1.3 billion.

In addition, TIGTA found that the IRS did not always ensure that the required source credit forms were attached to paper-filed tax returns. Finally, the IRS needlessly expended approximately $76,000 to review 145,583 tax returns for which a programming error incorrectly identified an error in the computation of the General Business Credit.

General Business Credit are supposed to serve as an incentive for a business to engage in certain kinds of activities that are considered beneficial to the economy or the public at large, such as improving disability access at their business for customers or providing childcare for employees.  The objective of TIGTA’s review was to assess the effectiveness of the IRS’s controls for detecting and preventing dubious claims for the General Business Credit on individual income tax returns.

“As with other tax credits, the General Business Credit serves a useful purpose and the IRS must prevent its abuse,” said TIGTA Inspector General J. Russell George in a statement. “In these difficult fiscal times, it is imperative the IRS develop processes to identify unsupported and potentially erroneous claims.”

TIGTA recommended that the IRS develop processes to identify individuals claiming a General Business Credit on tax returns with unsupported and potentially erroneous claims for General Business Credits.

The IRS agreed with all of the recommendations and plans to develop a compliance strategy that considers the treatment and resources to address questionable claims. In addition, the IRS said it plans to use the strategy to determine the need for procedural changes for returns processing, revisions to forms or instructions, and any underlying programming changes to its systems.

Peggy Bogadi, commissioner of the IRS’s Wage and Investment Division, noted the most substantial finding in the report is attributable to claims for the Energy Efficient Home Credit, or EEHC. 

“The Treasury Inspector General for Tax Administration suggests that some of the questionable claims may have been attributable to taxpayers mistakenly claiming the EEHC when they intended to claim the Residential Energy Credit,” she wrote in response to the report. “We agree with that assumption and believe it is supported, as noted in the report, by the finding that of the 1,956 taxpayers whose claims for tax year 2011 appear to be erroneous, only 65 of those taxpayers claimed a carryover credit on their 2012 return. We will review those claims, as well as any similar first-time claims made on 2012 returns by taxpayers not included in the 2011 analysis.”

However, she disagreed with some of the measurements cited by TIGTA in the report. “We disagree with the outcome measure of $195 million attributable to the gross EEHC claimed by the 65 taxpayers who initially claimed the credit on their 2011 returns, and continued to claim a carryforward of the credit on their 2012 return,” she wrote. “The outcome measure is based on the gross amount the taxpayers calculated on Form 8908, Energy Efficient Home Credit. Although the gross credit appears to be substantially inflated, the benefit the taxpayers receive over the 20-year carryforward period is limited to actual tax liability, and may be further reduced by any alternative minimum tax liabilities. We acknowledge that, left unchallenged, the taxpayers could avoid any net tax liability over 20 years; however, the projected harm to the government is not realistic. Using the TIGTA’s example, the taxpayer, averaging an actual tax liability of $2,000 per year, would realize a benefit of only $40,000 over the duration of the 20-year carryforward period. The remaining credit of $49,960,000 would expire, unused. Assuming a flat 35 percent tax rate, the taxpayer would need to have taxable income in excess of $7.1 million dollars in each of the 20 years in order to use the full amount of the erroneous credit.

“We do agree with the $4.8 million outcome measure, which reflects the actual benefit received by the 1,956 taxpayers who were allowed the EEHC on their 2011 returns,” she added. “The remaining outcome measures are not disputed. It should be noted, however, that programming changes to correct the erroneous referrals of some returns claiming General Business Credits to the Error Resolution System are scheduled to be implemented for the 2014 filing season, thus reducing the $378,680 outcome measure by $227,208.”

An IRS spokesman also sent a separate comment on the report Wednesday to Accounting Today. “The IRS is committed to improving our processes and procedures to reduce potentially erroneous claims for general business credits,” said the IRS. “The IRS has already begun making changes designed to insure that only eligible business taxpayers receive the general business credit and that the carryover of unused credits to future tax years is within the limits set by law. As we work within a tight budget environment, our efforts include an updating to our compliance strategy, refining paper return processing procedures, and revising forms and instructions.”