IRS Needs Better Controls over FTC Claims

The Internal Revenue Service does not have the controls and processes that it needs to avoid paying out erroneous Foreign Tax Credit claims, according to a new report.

The report from the Treasury Inspector General for Tax Administration covered the results of its analysis of individual tax returns from tax years 2010 through 2012, which identified $94.9 million in potentially improper Foreign Tax Credits across 65,499 returns. (In tax year 2013, taxpayers claimed more than $16.7 billion in Foreign Tax Credits.)

The IRS also allowed taxpayers to file 16,058 tax returns that claimed nearly $2.9 million in Foreign Tax Credits as a deduction, as well as a credit on the same foreign taxes paid. The service further allowed nearly $40 million in potentially erroneous Foreign Tax Credits on 188,102 tax returns when third-party information return documents did not support the Foreign Tax Credits claimed, and incorrectly transcribed the Foreign Tax Credit on 4,806 taxpayer accounts.

Paid tax preparers were responsible for 73 percent of tax returns with improperly allowed FTCs.

“The IRS should always make sure that compliance checks exist when taxpayers fail to take the required steps in order to claim a credit, and this is especially important for potentially large credits like the Foreign Tax Credit,” said Treasury Inspector General for Tax Administration J. Russell George.

Takeaways

TIGTA recommended that the IRS:

• Establish controls to ensure that the Form 1116, Foreign Tax Credit, is attached when required;
• Ensure that any training materials and additional guidance related to Foreign Tax Credits are updated, and that employees comply with the updated guidance;
• Develop a compliance strategy to address the risks identified with taxpayer FTC issues;
• Capture and maintain key FTC statistics;
• Improve education, outreach and enforcement activities to correct the paid preparer issues related to the Foreign Tax Credit; and,
• Revise the Internal Revenue Manual and the Specialist Referral System User Guide to clearly define the referral criteria that will be followed to ensure that tax returns in the examination function inventory with Foreign Tax Credits are referred as required.

IRS officials agreed with five of TIGTA’s recommendations and have taken or plan to take corrective actions. In addition, the IRS partially agreed with the remaining recommendation to identify and track key FTC statistics. The IRS has implemented a system to assist in identifying potential noncompliance and trends involving international issues, including the Foreign Tax Credit. However, further enhancements to gather statistics are not possible due to current budget and resource restrictions.