Internal Revenue Service Commissioner John Koskinen testified before the House Ways and Means Oversight Subcommittee on Wednesday about the 2014 tax filing season and other matters, including problems with administering the Earned Income Tax Credit and oversight of tax preparers.
The hearing also dealt with other issues facing the IRS, including efforts to prevent waste, fraud, and abuse, implementation of the Affordable Care Act, promoting fairness in examinations and tax administration, and changes at the agency to address the findings of targeting by the Treasury Inspector General for Tax Administration and congressional investigations.
In his prepared testimony, Koskinen discussed these matters, as well as the challenges of regulating tax preparers in the aftermath of a series of court rulings that invalidated the IRS’s efforts to require testing and continuing education of preparers.
“The IRS has continued to focus on service and compliance activities in regard to tax return preparers,” he said. “Return preparers play a key role in increasing taxpayer compliance and strengthening the integrity of the U.S. tax system. The IRS requires anyone who prepares or assists in preparing federal tax returns for compensation to have a valid Preparer Tax Identification Number (PTIN). PTINs allow the IRS to collect more-accurate data on who is preparing returns, the volume and types of returns being prepared and the qualifications of those doing return preparation. Additionally, PTIN data is essential in determining where to direct compliance and educational outreach efforts for erroneously prepared tax returns.”
Koskinen pointed out that the IRS recently held a successful PTIN renewal season, offering enhanced PTIN system usability, troubleshooting tips and other tools. As of March, the number of valid PTINs totaled approximately 677,000.
EITC Problems
Koskinen highlighted the complex nature of the rules governing eligibility for the Earned Income Tax Credit, and pointed out that the IRS engages in significant education and outreach efforts so taxpayers are aware of their potential eligibility for the credit. The IRS also takes steps to try to minimize the growing number of erroneous claims for the EITC.
The IRS’s EITC-focused enforcement programs currently protect approximately $4 billion annually, according to Koskinen. The agency has a number of programs that contribute to a broader strategy of identifying improper EITC refund claims as early in the process as possible. These include an automated process in which the IRS has been granted statutory authority to identify certain math or other irregularities on the return and automatically adjust the return for a taxpayer. However, the IRS has also asked Congress to grant it expanded math error authority.
The document-matching process involves comparing income information provided by the taxpayer with matching information from third-party returns, such as Form W-2 and Form 1099, to identify discrepancies. The IRS conducted nearly 1 million of these reviews in fiscal year 2013, in addition to 500,000 audits, Koskinen noted.
The IRS also identifies tax returns and amended returns for examination, and in most cases holds the EITC portion of the refund until an audit can be completed. Of the approximately 500,000 EITC audits conducted by the IRS each year, 70 percent are conducted before the EITC portion of the refund is paid, Koskinen pointed out. The tax returns to be examined are selected using an effective risk-based audit selection model, resulting in a change rate of more than 90 percent. Examinations protected almost $2.1 billion against improper EITC refund claims each year.
The IRS also uses soft notices as a low-cost alternative to audits. “They help educate taxpayers on their compliance responsibilities and are an inexpensive way of recovering payments,” said Koskinen.
In fiscal year 2013, the IRS sent more than 110,000 letters to alert taxpayers that an exemption or qualifying child for the EITC claimed on their returns had also been claimed by another person.
Under Section 32(k) of the Tax Code, the IRS is authorized to ban taxpayers from claiming the EITC for two years if it determines during an audit that they claimed the credit improperly due to reckless or intentional disregard of the rules. The IRS can impose a 10-year ban in cases of fraud, Koskinen noted, but when a ban is imposed, taxpayers are provided their full appeal rights. Last year there were more than 67,000 two-year bans and 45 10-year bans in effect.
Tax Preparers and EITC Due Diligence
The IRS is also continuing working to improve and expand its existing compliance efforts to stop improper EITC payments, but Koskinen said that tax preparers need to be part of that effort.
“Notably, our increased efforts in regard to identity theft-related fraud detection have helped improve EITC enforcement results,” said Koskinen. “In spite of these accomplishments, it is important to note the significant degree of difficulty in enforcing compliance with the EITC, which derives in large part from its eligibility requirements. EITC eligibility depends on items that the IRS cannot readily verify through third-party information reporting, including marital status and the relationship and residency of children. In addition, the eligible population for the EITC shifts by approximately one-third each year, making it difficult for the IRS to use prior-year data to assist in validating compliance. Given this situation, and given that approximately 57 percent of the returns claiming the EITC are prepared by tax return preparers, we believe that one of the keys to driving increased EITC compliance continues to be strategic programs addressed to the return preparer community, such as our return preparer initiative.”
He cited several examples of the IRS’s preparer-related activities, including compliance and warning notices sent before and during the filing season to preparers who prepare large numbers of EITC returns to educate them on their responsibilities and the consequences of noncompliance; tax preparer audits done by field examiners to make sure preparers are complying with EITC due diligence rules; and “knock-and-talk” visits to preparers by Criminal Investigation agents and auditors, to educate them on EITC laws.
In addition, the IRS has expanded its traditional treatment of EITC preparers to test a new early-intervention component, Koskinen noted. “Over the previous two years the IRS has used data analytics—including an innovative approach—to significantly reduce improper payments associated with the EITC as well as the CTC [Child Tax Credit]. Using this approach, a small data-driven pilot in 2012 identified a group of tax return preparers with a history of submitting incorrect or potentially fraudulent tax returns falsely claiming the EITC, then designed and implemented interventions with these preparers to stop improper claims. The interventions included letters, calls and site visits to selected preparers, both before and during tax filing season to allow preparers to immediately adjust their practices. These efforts reduced improper EITC payments in 2012 by an estimated $198 million for returns prepared by preparers who received the interventions.”
An expanded preparer pilot program in 2013 protected an additional $590 million in revenue from being paid out improperly, Koskinen noted. The 2013 pilot program included a broader set of randomly selected preparers and a broader set of interventions, including the addition of preparer-focused taxpayer audits (for returns that otherwise would have qualified for audit even absent the pilot).
“Many preparers whose error rates did not improve as a result of interventions during the 2012 pilot did so in 2013 after being subject to additional intervention,” said Koskinen. “Preparers who had improved due to IRS interventions during the initial 2012 pilot generally maintained their improved behavior with respect to EITC and related tax credits claimed on returns and claims filed during 2013. Use of interventions for preparers before and during the filing season continued on an expanded basis in 2014.”
Despite all of those efforts, however, Koskinen said the IRS continues to be concerned that the improper payment rate for the EITC has remained too high throughout the program’s history.
For fiscal year 2013, for example, the EITC improper payment rate was between 22 and 26 percent. Therefore, the IRS has recently initiated a major review of its activities in this area. “As part of this review we are assessing our many past and current efforts, and are exploring new possibilities, such as options for simplifying EITC eligibility requirements and finding more-efficient ways to distinguish valid claims from excessive claims,” said Koskinen.
Expanded Penalties for Tax Preparers
Koskinen also outlined a number of legislative proposals from the Treasury Department’s Green Book and the Obama Administration’s proposed budget that he said would play a critical role in the IRS’s effort to lower the improper payment rate. Those include congressional approval of the IRS’s authority to regulate paid tax preparers.
“In light of recent court decisions striking down the IRS’ authority to regulate unenrolled and unlicensed paid tax return preparers, the Administration’s proposal would explicitly authorize the IRS to regulate all paid preparers. In explaining the reason for this proposal, the Treasury Department noted that the regulation of all paid preparers, in conjunction with diligent enforcement, will help promote high-quality services from tax return preparers, improve voluntary compliance, and foster taxpayer confidence in the fairness of the tax system,” said Koskinen. “Treasury also noted the harms caused by incompetent and dishonest preparers to the tax system, including increased collection costs, reduced revenues, the burden placed on taxpayers by the submission of incorrect returns on their behalf, and a reduction in taxpayers’ confidence in the integrity of the tax system.”
Other proposals include expanding the penalties for tax preparers.
“Under current law, the penalty imposed on preparers for understatement of tax on a federal return due to an unreasonable position taken on the return is the greater of $1,000 or 50 percent of the income derived by the preparer from preparation of the return,” said Koskinen. “A separate penalty can be imposed if the understatement is due to the preparer’s willful or reckless conduct. That penalty is the greater of $5,000 or 50 percent of the income derived by the preparer from preparation of the return. The Administration’s proposal would increase the penalty in cases of willful or reckless misconduct to the greater of $5,000 or 75 percent of the income derived by the preparer (instead of 50 percent). Treasury has said this proposal is necessary because in many cases, 50 percent of income derived by the preparer is far greater than the fixed dollar penalties imposed, so that, under the present penalty regime, preparers who engaged in reckless or willful conduct would end up paying the same dollar penalty as preparers whose conduct did not rise to that level.”
Another proposal relates to the EITC due diligence requirements imposed on preparers. “Return preparers who prepare tax returns on which the EITC is claimed must meet certain due diligence requirements to ensure their clients are in fact eligible to receive this credit,” said Koskinen. “In addition to asking questions designed to determine eligibility, the preparer must complete a due diligence checklist (Form 8867) for each client, and file the checklist with the client’s return. The Administration’s proposal would extend the due diligence requirements to all federal income tax returns claiming the CTC [Child Tax Credit] and the ACTC [Additional Child Tax Credit]. The existing checklist would be modified to take into account differences between the EITC and CTC.”
In addition, Koskinen pointed out that the IRS currently has limited “math error authority” to identify certain computation or other irregularities on returns and automatically adjust the return for a taxpayer. These upfront systemic processing checks protect approximately $320 million in improper EITC payments annually. At various times, Congress has expanded this limited authority on a case-by-case basis to cover specific newly enacted Tax Code amendments. The Administration’s proposal would replace the existing specific grants of this authority with more general authority covering computational errors and incorrect use of IRS tables. “Further, the proposal would expand IRS’ authority by creating a new category of correctible errors,’ allowing the IRS to fix errors in several specific situations, such as when a taxpayer’s information does not match the data in government databases,” said Koskinen. “Without correctible error authority, any obvious errors in a return can only be fixed after an audit, which requires far more resources than we presently have. “
Koskinen also called for acceleration of information return filing dates. Under current law, most information returns, including Forms 1099 and 1098, must be filed with the IRS by February 28 of the year following the year for which the information is being reported, while Form W-2 must be filed with the Social Security Administration by the last day of February. “The due date for filing information returns with the IRS or SSA is generally extended until March 31 if the returns are filed electronically,” Koskinen observed. “The Administration’s proposal would require information returns to be filed with the IRS (or SSA, in the case of Form W-2) by January 31, except that Form 1099-B would have to be filed with the IRS by February 15. The proposal would also eliminate the extended due date for electronically filed returns. In addition, it would rationalize income tax return dates so that taxpayers would receive Schedule K-1 before the due date for filing their tax returns.”
Other legislative proposals in the Administration’s fiscal year 2015 budget request would also assist the IRS in its efforts to combat identity theft, Koskinen noted. They include giving the Treasury Department and the IRS authority to require or permit employers to mask a portion of an employee’s SSN on W-2s, an additional tool that would make it more difficult for identity thieves to steal SSNs; adding tax-related offenses to the list of crimes in the Aggravated Identity Theft Statute, which would subject criminals convicted of tax-related identity theft crimes to longer sentences than those that apply under current law; and adding a $5,000 civil penalty to the Tax Code for tax-related identity theft cases, to provide an additional enforcement tool that could be used in conjunction with criminal prosecutions.
Identity Theft Protection
The IRS has been focusing on combating tax-related identity theft and tax fraud. “Even with declining resources, our Criminal Investigation (CI) division has already this year initiated 2,015 investigations, recommended 1,663 prosecutions and secured 1,590 convictions,” said Koskinen. “The IRS has a comprehensive and aggressive identity theft strategy that focuses on preventing refund fraud, investigating these crimes and assisting taxpayers victimized by identity thieves.”
Koskinen noted that the IRS stopped 5 million suspicious returns in calendar year 2012, up from 3 million suspicious returns stopped in 2011. The upward trend has continued. In 2013, the IRS suspended or rejected 5.7 million suspicious returns, worth more than $17.8 billion. This year, through April 17, approximately 3 million suspicious returns have been stopped.
In 2008, the IRS began placing an indicator on the accounts of taxpayers who had experienced identity theft. “These indicators initially served two primary purposes: to speed up account reconciliation for the legitimate taxpayer, and to reduce the likelihood that a taxpayer’s information could be used for a fraudulent refund claim in subsequent years,” Koskinen explained.
In 2011, the IRS launched a pilot program to test the Identity Protection Personal Identification Number, or IP PIN, a unique identifier that authenticates a return filer as the legitimate taxpayer at the time the return is filed. The IP PIN is sent to the taxpayer immediately before the filing season for use on the return that will be filed during that filing season and is valid for only one filing season. The growth in the use of the IP PIN has been significant, Koskinen noted, from 250,000 IP PINs issued in filing season 2012 to more than 1.2 million IP PINs this filing season.
In previous years, the IRS typically offered the IP PIN to victims of identity theft. This year, however, the IRS offered a limited pilot program to test the idea of issuing IP PINs to individuals who have not previously been identity theft victims, but who reside in locations with high incidences of identity theft.
“This could prove to be a valuable initiative for next year’s filing season,” said Koskinen.
Over the last two fiscal years the IRS has made numerous improvements in its efforts to protect identifying information as well as catch fraud before refunds are issued, Koskinen noted.
The IRS has implemented new identity theft screening filters to improve its ability to spot false returns before it processes them and issue refunds. The IRS has also accelerated, to the extent it can under the present law, the use of information returns in order to identify mismatches earlier. In cases where dozens or even hundreds of refunds go to a single bank account or single address, the IRS has added identity theft filters last year that flag these multiple refund situations for further review.
“We plan further actions in this area for the next filing season,” said Koskinen.
