Friday, October 7, 2011
THE EARNED INCOME CREDIT AND TAX FRAUD
I received a notice from the IRS yesterday as part of my subscription service that reported the following -
“The Internal Revenue Service announced today that it is issuing proposed regulations that would require paid tax return preparers, beginning in 2012, to file a due diligence checklist, Form 8867, with any federal return claiming the Earned Income Tax Credit (EITC). It is the same form that is currently required to be completed and retained in a preparer’s records.
The due diligence requirement, enacted by Congress over a decade ago, was designed to reduce errors on returns claiming the EITC, most of which are prepared by tax professionals.
The IRS created Form 8867, Paid Preparer's Earned Income Credit Checklist, to help preparers meet the requirement by obtaining eligibility information from their clients. Preparers have been required to keep copies of the form, or comparable documentation, which is subject to review by the IRS. To help ensure compliance with the law and that eligible taxpayers receive the right credit amount, the proposed regulations would require preparers, effective Jan. 1, 2012, to file the Form 8867 with each return claiming the EITC.”
The Earned Income Credit is a federal welfare program. As the notice explained -
“Unlike most deductions and credits, the EITC is refundable –– taxpayers can get it even if they owe no tax. For 2011 tax returns, the maximum credit will be $5,751.”
It is probably the most expensive federal welfare program. The notice further pointed out that –
“For 2009, over 26 million people received nearly $59 billion through the EITC.”
Because it is refundable the Earned Income Credit is a magnet for tax fraud.
Edwin Rubenstein, president of ESR Research issued a report in 2009 documenting abuse of the EITC. Rubenstein's 55-page report, "The Earned Income Tax Credit and Illegal Immigration: A Study in Fraud, Abuse, and Liberal Activism", was published in "The Social Contract", a quarterly journal of public affairs.
Rubinstein found that, "Year after year about one-third of all EITC returns are based on illegal multiple returns, phony Social Security numbers or claims of nonexistent children or spouses".
The General Accounting Office has reported that the IRS estimates between 27 and 32 percent of EITC dollars are collected fraudulently.
The Rubinstein report also identified the massive size of the Earned Income Tax Credit –
"EITC spending dwarfs that of the traditional welfare program – Temporary Assistance for Needy Families (TANF) – and food stamps combined."
Just about every tax preparer has had at least one EITC client who we learned after-the-fact, or strongly suspected, had sufficient unreported income to make them ineligible for the credit. And I would expect each one of us, at one time or another, had as a client the single parent with apart-time W-2 that also had an unreported, and unknown to us, side-line cash business cleaning houses and apartments? Or the Schedule C client who reported just enough income to max-out their Earned Income Credit?
The Earned Income Credit does not provide the safeguards and checks and balances required in other federal and state welfare programs and necessary for responsible fiscal management. Hence the IRS requirement for additional “due diligence” when claiming the credit for a client. But simply asking questions of a client really is not sufficient.
And as tax professionals we have enough to worry about just getting all the necessary information from our clients without the added burden of having to determine if a person qualifies for federal welfare.
As I have been saying for years, the Earned Income Credit, and many other similar “tax expenditures”, does not belong in the Tax Code. The reasoning behind the existence of the EITC and many of the other tax expenditures is not necessarily bad. But they would be more appropriately and effectively distributed via direct “point of purchase” grants by the specific cabinet agency to which they apply, with all the accompanying checks and balances to verify the recipients’ qualification.
The EITC is one of the main reasons that close to half of Americans pay absolutely no federal income tax.
As a preparer I have no problem with being required to attach the due diligence form to the client’s return. Hey, it has to be completed anyway, so it is not additional work. I do not have that many clients who claim the credit anymore – and since I do not accept new clients I do not expect to have many, if any, more – so it is not a major issue in my practice. My problem is, as I said above, with the existence of the EITC in the Tax Code, and forcing tax preparers to take on the added burden of having to determine if a person qualifies for federal welfare.