Homebuyer Tax Credit Proved Tricky This Tax Season

The First-Time Homebuyer Credit turned the 2010 tax filing season into a briar patch for the Internal Revenue Service, a frustrating experience for many taxpayers, and a new opportunity for scammers to rip-off the public, an IRS official told Congress.

In testimony wrapping up the tax service’s performance during this year’s filing season, IRS National Taxpayer Advocate Nina Olson told the Senate Finance Committee on Thursday that the FTHBC was “the most significant challenge for the IRS” this tax season.

The credit, a cornerstone of the Obama administration’s effort to bolster the residential real estate market during the economic downturn, has instead created taxpayer confusion and frustration, and caused lengthy processing delays at IRS, she said.

The key problem is the complexity of the homebuyer credit, which requires taxpayers to make numerous calculations and decisions to determine the type of credit and the amount to which they are entitled.

“Each of these requirements creates a risk that the taxpayer will make an error,” Olson told the committee. “Even the eligibility dates are complex.”

As an example, she noted that a taxpayer could satisfy the contract date deadline but, “for reasons outside his or her control,” not meet the closing date deadline and therefore become ineligible.

“I predict that the two different repayment requirements — 15 years and none — will lead to considerable frustration from affected taxpayers about the perceived arbitrariness and inconsistency of the provision, beginning in the 2011 filing season when taxpayers who received the credit under the 2008 legislation must begin paying it back,” she said. “Taxpayers may direct their frustration at the IRS, even though the IRS is simply administering the law’s complex requirements as enacted.”

Adding insult to injury, the IRS’s plan to rely on third-party data to correct taxpayer math errors and repayment determinations for the credit “may lead to incorrect determinations that negatively impact taxpayers,” Olson testified.

To verify eligibility for the FTHBC, the IRS uses “internal and external data to determine whether there was prior qualifying home ownership, and there is no guarantee that the information is accurate or current,” she said. A taxpayer inaccurately identified by a third party as needing to repay the credit would likely have to undergo a “burdensome and costly” examination process to prove that he or she is not subject to recapture.

In addition to frustrating honest taxpayers who make inadvertent errors, the prospect of federal tax credits of as much as $8,000 per return has made the program “an attractive target for persons seeking to perpetrate fraud on the tax system,” Olson told Congress.
There have already been a significant number of fraudulent FTHBC claims uncovered, and at least 185 criminal schemes involving the homebuyer credit were being actively investigated by the IRS earlier this year, she said.

Potentially, however, the biggest problem associated with the credit is the processing traffic jam it is causing within the IRS itself.

Taxpayers seeking the FTHBC must submit enhanced documentation — a requirement that effectively prevents them from filing electronically. This not only drives up processing costs for IRS, but also delays the process.

Taxpayers are being told to expect a two- or three-week delay in their refunds if they apply for a homebuyer credit, but those delays may stretch out for months if the IRS decides that claims for homebuyer credits require further review.

“It is taking the IRS, on average, 122 days to close an examination of a return selected solely for FTHBC issues,” Olson explained. For an amended return seeking a homebuyer credit, the average procession delay is 150 days, she said.

The larger problem, though, is that the complexities associated with handling homebuyer tax credits may force the IRS to divert resources away from its “core work,” Olson told the Senate panel.

The latest audit statistics suggest that more than one-in-every-seven returns claiming a FTHBC is selected for examination by the IRS, and almost 21 percent of the correspondence audits launched during the first five months of fiscal year 2010 involved homebuyer credit concerns.

Given the current trends, “it is likely that FTHBC examinations will displace a significant additional number of regular discretionary audits before the year is through,” Olson predicted.

Despite the problems associated with the homebuyer credit, Olson gave generally good marks to the IRS for its handling of this year’s filing season.

Indeed, she praised the tax service for its performance “during the last two years as it simultaneously has delivered on its core mission of providing taxpayer services and collecting taxes while administering a number of economic stimulus programs, including the issuance of economic stimulus payments in 2008 and the processing of claims for the First-Time Homebuyer Credit in 2009.”

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