The Internal Revenue Service may have paid $3.2 billion in erroneous American Opportunity Tax Credits during the first five months of 2010 to 2.1 million taxpayers, according to a new government report.

The report, by the Treasury Inspector General for Tax Administration, found that 1.7 million taxpayers erroneously received an estimated $2.6 billion in education credits even though the IRS had no supporting documentation that they had attended an accredited institution of higher learning.

While the IRS initially did not agree with the amount of erroneous claims identified by TIGTA, it subsequently informed TIGTA that it has found a high percentage of the claims with no supporting documentation to indeed be erroneous.

IRS management noted that they expect the percentage of erroneous tax credits to further grow and have increased the number of tax returns they plan to review with this condition in fiscal year 2012.

An estimated 52 percent of the returns with potentially erroneous education credits were prepared by paid tax preparers, who should have been aware of the eligibility requirements, said the report.

The problem stems from a refundable tax credit known as the American Opportunity Tax Credit, which was created under the American Recovery and Reinvestment Act of 2009 as a way to help taxpayers offset the cost of higher education. The credit has been extended to both 2011 and 2012 tax returns.
House Ways and Means Oversight Subcommittee Chairman Charles Boustany, R-La., said Thursday he was dismayed and concerned by the lack of progress by the IRS to prevent the erroneous payments of education tax credits. “The IRS is failing to protect taxpayer dollars and must take stronger steps to ensure education credits should go to those who deserve them,” he said in a statement. “In this case, taxpayers potentially lost $3.2 billion dollars.  Enough is enough. It's time for the IRS to start taking proactive measures to stop erroneous payments on the front end.”

TIGTA also found that 370,924 taxpayers received an estimated $550 million in education credits for which they were not eligible because they did not attend college for the required amount of time or were post-graduate students.

In addition, 84,754 students who did not have a valid Social Security Number were claimed by taxpayers who received $103 million in education credits. Each of these students had an Individual Taxpayer Identification Number, however.

The report also found that 63,713 taxpayers erroneously received an estimated $88.4 million in education credits for students claimed as dependents or spouses on another taxpayer’s tax return, and 250 prisoners erroneously received $255,879 in education credits.

“Based on the results of our review, the IRS does not have effective processes to identify taxpayers who claim erroneous education credits,” said TIGTA Inspector General J. Russell George in a statement. “If not addressed, this could result in up to $12.8 billion in potentially erroneous refunds over four years.”

TIGTA made 11 recommendations, including revising the current tax form to claim education credits; coordinating with the Department of Education to assess using its data files in tax return processing; revising compliance programs to identify taxpayers who erroneously claim the credit; and coordinating with the Treasury Department to determine whether legislation is needed to clarify whether the credit may be claimed for students who lack a valid SSN.

The IRS agreed with 10 of TIGTA’s recommendations and partially agreed with the remaining recommendation. The IRS disagreed with TIGTA’s recommendation to initiate a Tax Return Preparer Project to address those preparers associated with large volumes of erroneous education credit claims.

"The IRS believes, however, that the amount of erroneous claims speculated in the report is likely to be substantially overstated," wrote IRS Wage and Investment Division Commissioner Richard C. Byrd Jr., in response to the report.

He said the IRS disagreed with the premise on which TIGTA had made the assumption that up to 2.1 million taxpayers appear to have claimed and received erroneous education credits, noting that the observation is based on the inability to match certain tax returns claiming education credits with the corresponding information returns on Form 1098-T, Tuition Statement. He said there were legitimate reasons why the information on the Form 1098-T could differ from the amount of the credit allowed to the taxpayer, such as timing differences.

As for TIGTA's recommendation for a Tax Return Preparer Project to address tax preparers filing erroneous returns, he said the IRS would take steps to work with educational institutions and other outside stakeholders to ensure that Form 1098-T reporting is accurate, but the IRS did not consider a Tax Return Preparer Project appropriate at this time.

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