The Internal Revenue Service needs to improve its ability to identify tax preparers who submit improper Earned Income Tax Credit claims, according to a new government report.

The report, by the Treasury Inspector General for Tax Administration, acknowledged that the IRS has increased its efforts to improve compliance with the EITC. However, in tax year 2008, individuals claimed $49.2 billion in EITC; 66 percent of the returns were prepared by tax return preparers.

The EITC was created in 1975 to offset the impact of Social Security taxes for individuals who work but have low incomes. The refundable nature of the EITC and the complexity of eligibility requirements increase the likelihood of taxpayer error and fraud. The IRS estimates that between $11 billion and almost $14 billion in erroneous EITC claims are paid annually.

The IRS recognizes the role tax return preparers play in ensuring compliance with EITC requirements. Beginning in 1999, the IRS developed the EITC Paid Preparer Strategy in an effort to increase tax return preparer compliance with EITC requirements. TIGTA performed the latest audit to determine if the IRS’s EITC Paid Preparer Strategy effectively identifies and addresses tax return preparers who prepare tax returns with erroneous EITC claims.

“One of the most significant challenges the IRS faces in its efforts to address tax return preparers’ EITC compliance is its inability to identify everyone who prepares returns,” said J. Russell George, the Treasury Inspector General for Tax Administration. “Our study found that actions need to be taken to improve IRS’s effectiveness in identifying those preparers who are at high risk for submitting improper EITC claims.”

TIGTA made two recommendations to the IRS in its report, and the IRS agreed with one of those recommendations.

The TIGTA report found that the risk factors used in fiscal year 2010 did not include identification of tax return preparers who were identified as high risk in the prior year but had not received a Due Diligence Visit because they were included in a control group. In addition, the IRS did not exclusively use the probability score it developed when identifying and selecting preparers for a DDV.

As a result, the IRS incorrectly selected 378 tax preparers and missed 655 preparers. TIGTA estimates the shift in tax return preparers within the DDV treatment category could result in the IRS paying $25 million less in erroneous tax year 2010 EITC claims. Finally, the quality of the DDVs limited the success of IRS efforts to reduce tax return preparer noncompliance.

TIGTA recommended that the IRS Wage and Investment Division commissioner include a risk factor in the IRS’s computation of the probability score for tax return preparers who were identified in a previous year as a high-risk tax return preparer and were included in the control group, and select high-risk tax return preparers for a DDV based on the preparer’s probability score and volume of EITC tax returns prepared. The commissioner of the IRS’s Small Business/Self-Employed Division should also ensure the DDVs are properly performed, with adequate case documentation in support of the assessment or nonassessment of penalties, TIGTA recommended.

In response to the report, IRS officials agreed to implement actions to improve the probability scoring and the quality of the DDVs. However, IRS management did not agree with TIGTA’s recommendation to revise the selection of high-risk tax return preparers for a DDV. IRS management indicated the current process provides the flexibility needed to maximize the use of resources and allows for consideration of additional factors when needed. 

TIGTA said it is concerned that the IRS did not agree to implement its recommendation that could result in further reducing erroneous EITC payments. TIGTA said its analysis shows the IRS’s process does not result in the most efficient and effective use of limited DDV resources. “Our analysis of the volume of EITC tax returns prepared and the IRS probability score identified more high-risk tax return preparers for a DDV than the IRS identified,” said the report.

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