The Earned Income Tax Credit (EITC): Administrative and Compliance Challenges

Summary

The Earned Income Tax Credit (EITC) is a refundable tax credit available to eligible workers earning relatively low wages. Since the credit is refundable, an EITC recipient need not owe taxes to receive the benefit. Hence, many low-income workers, especially those with children, can receive significant financial assistance from this tax provision.

Studies indicate that a relatively high proportion of EITC payments are issued incorrectly. The IRS estimates that in FY2013, 22% to 26% of EITC payments—between $13.3 billion and $15.6 billion—were issued improperly. These improper payments can be overpayments or underpayments. The IRS’s most recent study (released in 2014) of the factors that lead to EITC overclaims—the difference between the amount of EITC claimed by the taxpayer on his or her return and the amount the taxpayer should have claimed—concluded that there were three major reasons that tax filers claimed the wrong amount of the credit:

Qualifying child errors: Some EITC claimants claimed children who were not qualifying children for the credit. The most frequent type of qualifying child error was the failure of the tax filer’s qualifying child to meet the credit’s residency requirement whereby the claimed child must live with the tax filer for over half the year in the United States. This was the largest error in terms of dollars of EITC overclaims.

Income reporting errors: Some EITC claimants misreported their incomes. For example, tax filers whose income was above the phase-out threshold amount would receive a larger credit if they underreported their income. This was the most common error in terms of its frequency among tax returns which included an EITC claim and also included an overclaim.

Filing status errors: Some EITC claimants used the incorrect filing status when claiming the credit. Specifically, married couples were filing as unmarried (as single or head of household) to receive a larger credit.

This IRS study—also referred to as the 2006-2008 EITC Compliance Study in this report, because it examined tax returns between 2006 through 2008—found largely the same results as a previous IRS study on overclaims, released in 1999. The 2014 study also found that the majority of taxpayers who overclaim the EITC are ultimately ineligible for the credit, rather than eligible for a smaller credit. The 2014 study did not estimate the proportion of errors which were intentional (i.e., fraud) versus “honest mistakes” made while attempting to comply with EITC rules

Unlike previous studies, the 2014 study also examined different types of paid tax preparers who prepared tax returns which included EITC claims (these tax returns are sometimes referred to as “EITC returns”). The study found that among paid tax preparers, unenrolled preparers were both the most common type of tax preparers of EITC returns and among the most prone to erroneous claims of the credit. Unenrolled tax preparers generally do not pass the same testing requirements as enrolled preparers (e.g., attorneys and CPAs) and in contrast to enrolled tax preparers are limited in how they can represent their clients before the IRS.

This report summarizes findings from the 2014 IRS study detailing the factors that can lead to erroneous claims of the credit, and describes the challenges the IRS may face in their efforts to reduce each type of error. It also examines the role of paid tax preparers on EITC error.