The Internal Revenue Service needed to scramble to implement various provisions of last year’s Recovery Act to boost the economy as quickly as possible, but it now has to improve its enforcement and reporting to safeguard against abuses, according to a government report.

The Government Accountability Office focused in its report on five provisions of the stimulus legislation: the First-Time Homebuyer Tax Credit, the Making Work Pay Credit, the COBRA insurance subsidy for the unemployed, the expansion of net operating loss carrybacks for businesses to five years, and Build America Bonds for local and state government infrastructure projects.

Responding quickly to the Recovery Act involved trade-offs, the GAO noted. For example, because of the compressed time to implement the 2009 First-Time Homebuyer Credit, the IRS did not make computer changes to collect data, including the home purchase date. Without such information, the IRS was unable to easily distinguish 2008 and 2009 credits. “Distinguishing between the two credits is critical because they involve different requirements, including whether and how the credit is to be repaid,” said the GAO.

The IRS found that many taxpayers claimed the credit who were unqualified or submitted fraudulent or erroneous claims (see Audit Finds $636M in Bogus Homebuyer Credits).

The IRS has taken some steps to mitigate abuses, the GAO acknowledged. As a result of IRS’s pre-refund compliance reviews, as of Feb. 1, 2010, the IRS had frozen about 140,000 refunds pending civil or criminal examination, and, as of Dec. 2, 2009, it had identified 175 criminal schemes and had 123 criminal investigations open.

The Making Work Pay Credit is a refundable tax credit that provides up to $400 to working individuals and $800 to joint filers. The credit is reduced for single filers with modified adjusted gross incomes in excess of $75,000 and joint filers with incomes over $150,000.  Taxpayers may receive the credit throughout the year in the form of lower amounts of tax withheld from their paychecks. The IRS needed to quickly issue a new set of withholding tables so taxpayers could immediately benefit from the credit through reduced federal tax withholding. The Treasury decided not to fully account for the effect of the credit on taxpayers whose incomes were in the phaseout range. As a result, taxpayers with incomes in the phaseout range did not receive a precisely calculated tax reduction.

In November 2009, IRS issued new withholding tables for 2010 that included two new brackets to better recognize the effect of the credit on taxpayers in the phaseout range. The withholding changes may also have unfavorable consequences for some other taxpayers. For instance, the Treasury Inspector General for Tax Administration recently reported that over 15 million taxpayers, such as those receiving pensions and joint filers with two or more jobs between them, may be negatively affected. These taxpayers may owe taxes or receive a lesser or no refund because not enough taxes were withheld from their paychecks to satisfy their eventual tax obligation or maintain previous withholding levels.

With the net operating loss carryback, as soon as the Recovery Act was enacted, taxpayers began filing three-, four-, and five-year NOL carryback claims, which allowed them to use 2008 small business losses to reduce taxable income from three, four, or five years before and get tax refunds quickly. Because taxpayers made claims before the IRS issued its guidance on March 16, 2009, taxpayers made what IRS officials considered invalid or unclear elections on their NOL carryback claims. Despite the March 16th guidance, taxpayers continued to file unclear carryback claims because they appeared to have not followed the instructions in the guidance, which told taxpayers to attach a statement to their tax return indicating certain information.

Officials processed the claims and decided to issue on May 11, 2009, a second piece of guidance superseding the March 16th one in order to make the process easier for taxpayers. The May 11th guidance reduced the burden on taxpayers by allowing them to file the appropriate NOL carryback form without having to attach an election statement. By reviewing the computations on the appropriate form, the IRS was able to find the information it needed to process the claim.

However, when processing takes more than 45 days, the IRS has to pay interest on NOL refunds, just as it must for other refunds taking more than 45 days to process. In order to process the claims on time, the IRS initially took one to two revenue agents at seven campus locations away from examination cases for one to two days per week to determine whether small businesses’ three-year average gross receipts were under a $15 million ceiling, making them eligible for the NOL carryback refunds. This lasted for about two months until the IRS developed a Gross Receipts Average Calculator tool. This tool replaced the need for extensive revenue agent involvement by automatically calculating a taxpayer’s average gross receipts.

Problems also arose with the COBRA subsidy. The COBRA provision originally provided a 65 percent health insurance subsidy for up to nine months for individuals who lost health insurance coverage due to involuntary termination between Sept. 1, 2008, and Dec. 31, 2009.  Former employers, or in some cases multiemployer health plans or insurers, pay 65 percent of insurance premium costs and are reimbursed through a tax credit against their payroll tax liability or through a tax refund if the credit exceeds their payroll tax liability.

However, the GAO noted that COBRA data will often understate the number of individuals receiving health insurance. For instance, if COBRA premium assistance was paid for a former employee, his or her spouse, and one child, an employer would count that as one person provided assistance. According to IRS officials, the relevant form did not include dependents due to a short implementation time frame, space constraints on the form, and a desire not to overburden employers with additional reporting requirements.

To identify fraudulent or erroneous COBRA claims made by employers, the IRS instituted a number of prepayment checks, such as looking for irregularities in COBRA claims and in the dollar value of subsidies. As of Sept. 22, 2009, the prepayment checks had stopped about 1,500, or 2 percent, of COBRA claims for further review.

Other compliance challenges have not been resolved. For example, the IRS does not know who receives the COBRA subsidies, which limits its ability to determine if a taxpayer is qualified to receive a subsidy and to ensure that employers do not receive the credit for ineligible individuals. In an effort to reduce the employer burden, the IRS did not require employers to submit lists of all people receiving COBRA. As a result, it was only aware of the number of individuals an employer reported on Form 941 and the total amount of the subsidy claimed. Employers are required by the IRS to keep records of the COBRA assistance, including the names and Social Security numbers of covered employees, but the IRS would see this information only during any examinations.

Build America Bonds are taxable government bonds that can be issued with federal subsidies for a portion of the borrowing costs delivered either through nonrefundable tax credits provided to holders of the bonds or as refundable tax credits paid to state and local governmental issuers of the bonds.

However, the IRS’s reporting requirements for the bonds are minimal in contrast to requirements for Recovery Act infrastructure and other direct spending projects, even though such projects may be similar, the GAO noted. For example, funding for both Recovery Act spending projects and BABs may be used for highway, school, water, sewer, or utility improvements. Currently, the IRS requires state and local governments to submit an information return at the time of bond issuance that describes the type of bond issue, issue price, weighted average maturity, yield percentage, and the use of bond proceeds.

The GAO recommended that Congress consider authorizing the IRS to publish more BAB information and grant the IRS broader authority to correct errors during tax-return processing. The GAO also recommended that the IRS obtain more information on BABs, enhance compliance with the COBRA provision, and prepare a report on the lessons learned from the Recovery Act.

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