oversight

Earned Income Credit: Qualifying Child Certification Test Appears Justified, but Evaluation Plan Is Incomplete

Published by the Government Accountability Office on 2003-09-30.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                 United States General Accounting Office

GAO              Report to Congressional Requesters




September 2003
                 EARNED INCOME
                 CREDIT
                 Qualifying Child
                 Certification Test
                 Appears Justified, but
                 Evaluation Plan Is
                 Incomplete




GAO-03-794
                 a
                                               September 2003


                                               EARNED INCOME CREDIT

                                               Qualifying Child Certification Test
Highlights of GAO-03-794, a report to
                                               Appears Justified, but Evaluation Plan Is
congressional requesters                       Incomplete



The Earned Income Credit (EIC), a              The Assistant Treasury Secretary and IRS Commissioner convened a task
tax credit available to the working            force to identify ways of reducing EIC overclaims while minimizing taxpayer
poor, has experienced high rates of            burden and maintaining the EIC’s relatively high participation rate. In August
noncompliance. Unlike many                     2002, the Secretary approved a recommendation to certify taxpayers’
benefit programs, EIC recipients               eligibility to claim EIC qualifying children. The proposal is based on analyses
generally receive payments without
advance, formal determinations of
                                               of the leading sources of EIC errors, thus focusing attention and burden on
eligibility; the Internal Revenue              the subset of taxpayers most likely to make those errors.
Service (IRS) checks some
taxpayers’ eligibility later. IRS              Since August 2002, IRS has made key changes to the certification program,
estimated that tax year 1999 EIC               including concentrating on residency certification and postponing
overclaim rates, the most recent               relationship certification, delaying program implementation until later this
data available, to be between 27               year, and reducing the test sample from 45,000 to 25,000. Despite the
and 32 percent of dollars claimed              changes, the process for selecting taxpayers, what taxpayers will receive
or between $8.5 billion and                    from IRS, what taxpayers are required to provide, and the program’s goals
$9.9 billion. To address overclaims,           remain fundamentally the same as originally planned. In addition, IRS has
IRS plans to test a new certification          emphasized that program expansions, if any, will depend on the results of
program.
                                               this year’s test. The process would involve three key stages as shown below.
Because IRS’s plans have garnered
much attention, you asked us to                The EIC Certification Process as Envisioned
(1) describe the design and basis
for the EIC qualifying child
certification program, (2) describe
the current status of the program,
including significant changes, and
(3) assess whether the program is
adequately developed to prevent
unreasonable burden on EIC
taxpayers and improve compliance
so that the test should proceed.



GAO recommends that the
Commissioner of Internal Revenue
accelerate the development of                  These changes, including the most recent, help achieve a better balance
IRS’s plan to evaluate the                     between preventing unreasonable taxpayer burden and addressing the EIC’s
certification test. The plan should            high overclaim rate and support IRS’s plans to test the certification program.
demonstrate how the program’s                  However, IRS’s plan for evaluating the test is incomplete, presenting only
objectives would be evaluated,                 some information on how IRS would evaluate whether certification would
including milestones for
                                               reduce the EIC overclaim rate, minimize burden, and maintain a relatively
conducting the evaluation. The
Commissioner said that IRS would               high participation rate. The plan proposes potential options for identifying
further develop its evaluation plan            how and when certain critical data will be obtained, but does not provide
as we recommended.                             further details on when decisions will be made or on the specific data that
www.gao.gov/cgi-bin/getrpt?GAO-03-794.         will be collected. Officials have developed preliminary drafts identifying
                                               data to be obtained and have begun considering how to use contractors to
To view the full report, including the scope   gather the data. Because the data relate to taxpayers’ actions that will occur
and methodology, click on the link above.
For more information, contact Michael          next spring, IRS appears to have some time to finalize its evaluation plan.
Brostek at (202) 512-9110 or
brostekm@gao.gov.
Contents



Letter                                                                                                1
                             Results in Brief                                                         2
                             Background                                                               5
                             Task Force Considered Much Information Related to EIC
                               Compliance before Recommending Qualifying Child Certification
                               Program                                                                9
                             IRS Has Made Key Changes to Its Initial Qualifying Child
                               Certification Program and More May Occur                              18
                             Qualifying Child Certification Program Developed to Improve
                               Compliance While Considering Taxpayers’ Burden, but Plan for
                               Evaluating Test Is Incomplete                                         31
                             Conclusions                                                             38
                             Recommendations for Executive Action                                    39
                             Agency Comments and Our Evaluation                                      40


Appendixes
               Appendix I:   Significant Noncompliance Rates Other Than for the EIC                  41
              Appendix II:   Overclaim Rates, Administrative Costs, and Eligibility
                             Verification Processes of Benefit Programs                              44
             Appendix III:   Objectives, Scope, and Methodology                                      50
                             Objectives                                                              50
                             Scope and Methodology                                                   51
              Appendix IV:   Key Milestones for the Qualifying Child Certification
                             Program                                                                 54
              Appendix V:    Documents Related to the Precertification Program                       55
             Appendix VI:    Comments from the Internal Revenue Service                              65
             Appendix VII:   GAO Contacts and Staff Acknowledgments                                  71
                             GAO Contacts                                                            71
                             Acknowledgments                                                         71


Tables                       Table 1: EIC Requirements for Tax Year 2002                              6
                             Table 2: EIC Overclaim Rates for 1997 and 1999                          10
                             Table 3: Recent Statutory Changes                                       12
                             Table 4: Overclaim Rates, Administrative Costs, and Eligibility
                                      Verification Processes for EIC and Other Programs              45
                             Table 5: How Overclaim Rates Are Calculated for Selected Benefit
                                      Programs                                                       49



                             Page i                                      GAO-03-794 Earned Income Credit
          Contents




          Table 6: Questions We Were Asked                                                       50


Figures   Figure 1: Estimated Percentage of EIC Taxpayers (with Children)
                    Who Made Residency Errors and Filed Single or Head of
                    Household in Tax Year 1999                                                   17
          Figure 2: IRS’s Process to Identify the Population of Taxpayers
                    from Which the 25,000 Person Test Sample Was Drawn                           22
          Figure 3: The EIC Certification Process as Envisioned                                  24
          Figure 4: Key Milestones for the Certification Program                                 54




          Abbreviations

          EIC          Earned Income Credit
          IRS          Internal Revenue Service
          AGI          Adjusted Gross Income
          FCR          Federal Case Registry
          SB/SE        Small Business/Self Employed
          NRP          National Research Program
          TCMP         Taxpayer Compliance Measurement Program

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          Page ii                                                 GAO-03-794 Earned Income Credit
A
United States General Accounting Office
Washington, D.C. 20548



                                    September 30, 2003                                                                            Leter




                                    The Honorable Amo Houghton
                                    Chairman, Subcommittee on Oversight
                                    Committee on Ways and Means
                                    House of Representatives

                                    The Honorable Earl Pomeroy
                                    Ranking Minority Member, Subcommittee on Oversight
                                    Committee on Ways and Means
                                    House of Representatives

                                    The Earned Income Credit (EIC), a tax credit available to the working poor,
                                    has generally been considered a successful antipoverty program by
                                    researchers. In recent years, the Internal Revenue Service (IRS) has paid
                                    about $30 billion annually to about 20 million EIC recipients. However, the
                                    EIC program has long experienced high rates of noncompliance. For tax
                                    year 1999, IRS estimated the EIC overclaim rates1 ranged between 27 and
                                    32 percent of dollars claimed or between $8.5 billion and $9.9 billion.
                                    Unlike many benefit programs, EIC recipients generally receive payments
                                    without a prior, complete review of their eligibility; IRS checks some
                                    aspects of taxpayers’ eligibility before and after the credit is granted.

                                    To help combat the high rates of noncompliance, IRS plans to test a new
                                    program, beginning in December 2003.2 Referred to as the qualifying child
                                    certification program, some taxpayers will be asked to verify EIC
                                    “residency” requirements3 for their qualifying children before getting that
                                    portion of their refund or reduction in tax liability. IRS plans to test the EIC
                                    program with 25,000 taxpayers whose residency cannot be confirmed

                                    1
                                     Overclaim rates are calculated based on erroneous claim amounts less any amounts IRS
                                    recovered or expects to recover, such as through examinations. IRS also has limited
                                    information on underclaim rates, or instances in which taxpayers claimed less than they
                                    were entitled to receive. This report primarily focuses on IRS’s efforts to address
                                    noncompliance related to overclaims using the qualifying child certification program.
                                    2
                                     The program discussed in this report is one part of a strategy to target three major known
                                    sources of EIC noncompliance. The other two parts involve the improper reporting of filing
                                    status, such as among married taxpayers who report as single or head of household to avoid
                                    reporting their spouse’s income, and income misreporting, such as underreporting earned
                                    income.
                                    3
                                     Taxpayers must meet multiple criteria in order to claim the EIC, as shown in table 1.
                                    Residence is one criterion for a taxpayer with a qualifying child.




                                    Page 1                                                    GAO-03-794 Earned Income Credit
                   through other means. Future plans for the program largely depend upon
                   the results of this test.

                   Because IRS’s plans surrounding the program have garnered much
                   attention, you asked us to respond to questions about the qualifying child
                   certification program. These questions cover various topics, such as the
                   status of the program, understandability of letters and forms going to
                   taxpayers, certification requirements and taxpayers’ ability to comply,
                   taxpayer burden, impact on compliance rates, impact of recent legislative
                   changes, and data from other federal or state benefit programs. We grouped
                   these questions into three objectives: (1) describe the design and basis for
                   the EIC qualifying child certification program as proposed by the EIC task
                   force, (2) describe the current status of the program, including significant
                   changes since program approval, and (3) assess whether the program is
                   adequately developed to (a) prevent unreasonable burdens on EIC
                   taxpayers and (b) improve compliance so that the test should proceed. In
                   addition, you asked us to provide readily available information on the
                   (1) significant noncompliance rates other than for the EIC and (2)
                   overclaim rates and administrative costs of comparable benefit programs
                   administered by states or the federal government and any verification
                   process used by these programs. This information is presented in
                   appendixes I and II, respectively.

                   This report is based primarily on our previous work and analysis of IRS and
                   Department of the Treasury documents and reports, new letters and forms
                   that will be sent to taxpayers, and interviews with senior officials at IRS
                   and Treasury. We did not verify the accuracy of reports or data obtained.
                   Rather, we reviewed the steps IRS officials had taken to implement the
                   program and determined, to the extent possible, how they assured
                   themselves that the program had been adequately developed to prevent
                   unreasonable burden and improve compliance. We did not determine the
                   adequacy of various other preparations for the qualifying child test, such as
                   staffing and training of staff. Appendix III provides more detail on the
                   scope and methodology used in conducting our work.



Results in Brief   Due to persistently high EIC noncompliance, among other factors, the
                   Assistant Secretary of the Treasury and IRS Commissioner convened a task
                   force in February 2002 to find ways of reducing EIC overclaim rates while
                   minimizing the burden to taxpayers and maintaining the EIC’s relatively
                   high participation rate. The task force considered the likely effect of recent
                   legislative changes on EIC compliance in formulating its proposal to



                   Page 2                                           GAO-03-794 Earned Income Credit
combat noncompliance. It also considered various options, such as
partnering with other federal or state agencies to verify EIC taxpayers’
eligibility. The task force analyzed data and reviewed studies to design the
program to focus on known sources of noncompliance. In August 2002, the
Treasury Secretary approved the task force recommendation that IRS
certify the eligibility of taxpayers’ qualifying children. Only taxpayers most
likely to make errors and whose qualifying child eligibility cannot be
verified from available information would be asked to certify.

Since taking its broad charge from the task force, IRS obtained input from
external and internal stakeholders, and made key changes to the
certification program, including (1) concentrating on residency
certification and postponing the relationship certification for an
undetermined period of time, (2) delaying program implementation until
later this year, and (3) reducing the test sample from 45,000 to 25,000.
According to IRS officials, the relationship portion of the program was
postponed indefinitely for several reasons, including concerns raised about
the proposed relationship certification form and studies that have shown
meeting requirements for relationship is less of a compliance issue than
meeting residency requirements. IRS had previously changed the start date
of the test, and, as we were finalizing this report, announced in August
2003, that it was again delaying the program and now plans to send letters
about the qualifying child certification program to taxpayers in December
2003. With this change, taxpayers will now have to provide proof that
qualifying children meet the residency test when they file their 2003
individual income tax returns; thus, any unresolved issues could result in
frozen refunds. As part of the August announcement, IRS also reduced the
number of taxpayers that will be included in the test from 45,000 to 25,000,
in part, in response to comments received during a 30-day public period.
However, these changes create additional challenges for IRS and taxpayers.
For example, the test will no longer be a direct test of the original concept
of certifying taxpayer eligibility in advance of the filing season. At the same
time, the process for selecting taxpayers, what taxpayers will receive from
IRS, and what taxpayers will be asked to provide to prove the residency of
a qualifying child remains basically the same as originally planned. Further,
IRS officials have emphasized that program expansions, if any, will depend
on the results of the test.

The changes made in the proposed certification program—including the
ones announced in August—help achieve a better balance between
preventing unreasonable taxpayer burden and addressing the EIC’s high
overclaim rate, and support IRS’s plans to move forward with the residency



Page 3                                           GAO-03-794 Earned Income Credit
test. The qualifying child program is based on analyses of the leading
sources of EIC errors, thus focusing attention and burden on the subset of
taxpayers making those errors as opposed to all EIC recipients. In addition,
IRS has taken steps to address the burden taxpayers will experience as
participants in the test this year. However, IRS’s plan for evaluating the
results of the test is not yet complete. Although an evaluation plan does not
have to completely identify all issues or how they will be evaluated prior to
a program’s start, the more completely a plan is developed, the more likely
that the evaluation will be sufficient to support future decisions. The draft
evaluation plan presents only some information on how IRS will show
whether certification’s objectives—reduce the overclaim rate, minimize
burden, and maintain the EIC’s relatively high participation rate—will be
achieved. However, the plan proposes potential options for identifying
how and when some critical data will be obtained and analyzed, but does
not provide further details on when, how, and by whom decisions will be
made on the specific data that will be collected. Officials have developed
preliminary drafts identifying data to be obtained and have begun
considering how to use contractors to gather the data. Since the data
relates to taxpayers’ actions that will occur next spring, IRS has some time
to finalize the evaluation plan.

We are recommending that the Commissioner of Internal Revenue, to the
extent possible, accelerate the development of the evaluation plan, and
have the plan demonstrate how each program objective will be evaluated,
including milestones for critical steps such as how data will be obtained
and analyzed in time to support decisions about the future of IRS’s
certification program.

We requested comments on a draft of this report from the Commissioner of
Internal Revenue. We received written comments, which are reprinted in
appendix VI. In his comments, the Commissioner said that IRS would be
including the components we suggested in their evaluation plan and said
that IRS is working to incorporate these components well before the
certification test begins. We further discuss the Commissioner’s comments
in the “Agency Comments and Our Evaluation” section of the report.




Page 4                                          GAO-03-794 Earned Income Credit
Background   Congress enacted the EIC in 19754 with the goal of offsetting the Social
             Security taxes paid by the working poor and creating a greater work
             incentive for low-income taxpayers. According to data cited in the task
             force report, an estimated 4.3 million individuals were lifted out of poverty
             in 1998 by the EIC, including 2.3 million children.

             The EIC is a refundable tax credit, meaning that qualifying working
             taxpayers may receive a refund greater than the amount of income tax paid
             during the year. Taxpayers can qualify for the credit in one of two ways:
             with a “qualifying child” or by “income only,” if they do not have a
             qualifying child. For example, for tax year 2002, the amount of EIC that
             could be claimed with a qualifying child or children ranged from $0 to
             $4,140. EIC payments have a phase-in range in which higher incomes yield
             higher EIC amounts, a plateau phase in which EIC amounts remain the
             same even as income rises, and a phase-out range in which higher incomes
             yield lower EIC payments or tax liability.

             EIC requirements for tax year 2002 include rules for everyone, additional
             rules for taxpayers with qualifying children, and additional rules for
             taxpayers without qualifying children, as shown in table 1.




             4
             26 U.S.C. Sec. 32.




             Page 5                                          GAO-03-794 Earned Income Credit
Table 1: EIC Requirements for Tax Year 2002

                             Additional rules for        Additional rules for
Rules for all taxpayers      taxpayers with a qualifying taxpayers without a
claiming the EIC             child                       qualifying child
Must have a valid Social     Income limitations: If one       Income limitations: $11,060
Security number              child: $29,201 (or $30,201 if (or $12,060 if married filing
                             married filing jointly). If more jointly).
                             than one child: $33,178 (or
                             $34,178 if married filing
                             jointly).
Cannot use married filing    Child must meet age,             Must be at least 25 years
separately status            relationship, and residency      old, but under 65
                             tests
Must be a U.S. citizen or    Child can be claimed by one Taxpayer cannot be the
resident alien all year      taxpayer only               dependent of another
                                                         person
Cannot file form 2555 or     Taxpayer cannot be a             Taxpayer cannot be a
2555-EZ                      qualifying child of another      qualifying child of another
                             taxpayer                         taxpayer
Investment income must be                                     Must have lived in U.S. more
$2,550 or less                                                than half of a year
Must have earned income
Source: IRS.


IRS has periodically measured EIC compliance for overclaims and
underclaims. The most current data available, for tax year 1999, show EIC
overclaim rates estimated to be between 27 and 32 percent of dollars
claimed or between $8.5 billion and $9.9 billion. IRS has limited data on
underclaims, which for tax year 1999 were estimated to be between
$710 million and $765 million.5 IRS has tried to reduce noncompliance
through various means, including education and outreach to taxpayers and
tax return preparers. In addition, Congress has enacted legislation aimed at
resolving some concerns with EIC rules. Because a new analysis of EIC
compliance using 2001 tax return information is not expected to be
complete until late in 2004, IRS does not know whether compliance has
significantly changed since 1999, but officials do not think it has improved




5
 Underclaims refers to the amount in which taxpayers claimed less than what they were
entitled to receive.




Page 6                                                     GAO-03-794 Earned Income Credit
substantially. Because of the persistently high rates of noncompliance, we
have identified the EIC program as a high-risk area for IRS since 1995.6

Currently, taxpayers claim the EIC by filing an individual income tax return
(e.g., a Form 1040 or 1040A) and including a Schedule EIC—a procedure
similar for claiming other tax credits. Unlike with other benefit programs
such as Supplemental Security Income, however, EIC taxpayers are not
required to be found qualified before claiming the credit or file any other
documents with their return to establish eligibility. Instead, IRS uses four
primary means to evaluate EIC eligibility and check for noncompliance
after the return is filed and checks some aspects of taxpayers’ eligibility
before and after the credit is granted: (1) the math error program, (2)
correspondence and face-to-face examinations (also called audits), (3) the
document matching program, and (4) criminal investigations. Some of
these means, such as the math error program, check all EIC returns, but
only for limited aspects of eligibility. Other means, such as examinations,
only check a small subset of EIC returns, but the review is more expansive.
In general, IRS subjects all returns to its math error program and takes
corrective action on errors found. Depending on the resources IRS has
available, IRS works only a small portion of cases identified as potentially
meriting follow-up under its examination, document matching, and
criminal investigations efforts.

While processing all tax returns, IRS uses its automated math error
program to identify and correct the simpler errors found in claiming the
EIC. For example, the math error program can identify invalid Social
Security numbers and taxpayers who fail to follow recertification
requirements.7 As a result, some inappropriate EIC claims are stopped
before refunds are issued. During fiscal year 2001, IRS stopped more than
371,000 incorrect EIC claims using its math error authority. After
identifying errors, IRS corrects them so the tax return can be processed
and sends a computerized notice to the taxpayer identifying the error and
stating that IRS disallowed or reduced the EIC claim. The notice tells


6
 Prior to 2001, EIC was part of a broader IRS tax filing fraud high-risk area. Beginning in
2001, the focus of that designation was narrowed to EIC specifically. U.S. General
Accounting Office, High-Risk Series: An Update, GAO-01-263 (Washington, D.C.: January
2001).
7
 Taxpayers are required to meet recertification requirements when they have been denied
the EIC in a previous year. Recertification involves taxpayers providing documentation,
such as a birth certificate, to support their claim of a relationship to a qualifying child.




Page 7                                                     GAO-03-794 Earned Income Credit
taxpayers that if they can correct the error, the EIC claim will be allowed
and any refund related to the EIC claim will be issued.

Two types of examinations—-correspondence and face-to-face—are used
when EIC noncompliance is suspected, in most cases before refunds are
issued. IRS uses various systematic means to “score” the likelihood of
noncompliance on any return and uses experienced staff to manually
identify the specific items on returns for examination. Most EIC
examinations occur shortly after a return is filed, largely because of the
difficulty in recovering refunds. IRS stops refunds on these returns until
examinations are completed. This contrasts with IRS’s normal examination
practice of performing examinations many months after tax returns have
been processed and any refunds paid. The EIC examinations usually rely
on correspondence with taxpayers rather than face-to-face contacts. IRS
completed about 368,000 EIC related correspondence exams during fiscal
year 2002. IRS tends to use face-to-face meetings with taxpayers to
examine tax returns with EIC claims on a very limited basis and primarily
when examinations are initiated for other reasons. As part of either type of
examination, however, IRS would describe the potential noncompliance in
a computerized notice to taxpayers claiming the EIC. IRS requests
documentation, such as a school record or birth certificate, to establish
EIC requirements. Depending on whether IRS officials accept or reject the
support, they may make changes to the return and refund related to the EIC
claim. If taxpayers disagree with IRS’s decisions, they have the right to
appeal administratively and/or through the courts.

IRS also uses its document matching programs to identify potentially
misreported income on tax returns claiming the EIC. By comparing the tax
return to wage and income statements provided by third parties such as
employers and financial institutions, the document-matching program
identifies whether a taxpayer appears to have misreported income. Given
the phase-in and phase-out ranges of the EIC, some taxpayers may claim
too much EIC by overreporting or underreporting their income. This
program notifies such taxpayers months after returns are filed and refunds
are issued. Similar to audits, a notice is issued telling a taxpayer that an
error appears to have been made, that he or she may disagree and provide
any support for income reported, and that he or she may appeal IRS’s
decision about additional taxes owed. Unlike audits, the program is highly
automated and is designed to require less contact with taxpayers by IRS
staff.




Page 8                                          GAO-03-794 Earned Income Credit
                         IRS also uses criminal investigations to stop the payment of false refunds,
                         identify refund scams/schemes, and prosecute perpetrators, including
                         those with fraudulent EIC claims. For EIC, IRS uses a specific computer
                         program that looks for questionable refund claims and for return preparers
                         known to have prepared questionable returns. IRS also has teams that scan
                         returns and receive referrals from other parts of IRS and informants. IRS
                         stops many returns as they are being processed so that criminal
                         investigators can review the claims before the refund is paid or after the
                         return has been processed.



Task Force Considered    When IRS’s study of EIC compliance rates for 1999 was released, the
                         Assistant Secretary of the Treasury and IRS Commissioner convened a
Much Information         task force in February 2002 to find ways of reducing EIC overclaims while
Related to EIC           minimizing the burden to taxpayers and maintaining the EIC’s relatively
                         high participation rate. The task force considered whether changes in
Compliance before        statutes recently enacted by Congress or proposed by Treasury may have
Recommending             lessened the need for new EIC compliance initiatives and concluded that,
Qualifying Child         while statutory changes addressed some sources of noncompliance, they
                         likely would not reduce other leading sources of noncompliance. The task
Certification Program    force also considered a range of new methods, including partnering with
                         other federal or state agencies or programs and developing a new database
                         to verify EIC eligibility before issuing tax refunds, but decided that these
                         options were not viable. Ultimately, the task force recommended the
                         qualifying child certification program. The task force reviewed IRS’s EIC
                         compliance study results and other data, as well as other studies, to
                         identify the sources and develop new methods of addressing
                         noncompliance.



Task Force Convened to   The joint Treasury and IRS task force addressed a long-standing problem of
Address Long-Standing    high EIC overclaim rates. Although the release of IRS’s 1999 compliance
                         study precipitated the formation of the EIC task force in February 2002, the
Compliance Problem       study results were generally consistent with high overclaim rates reported
                         in prior IRS studies. While some stakeholders view the 1999 study as having
                         some methodological weaknesses, it showed that of the approximately 20
                         million taxpayers that claimed the EIC in 1999, 46 to 50 percent of their tax
                         returns had errors that led to claiming too much of the credit (IRS often
                         refers to this as the error rate). IRS also estimated that the total dollars
                         overclaimed on those returns represented between 27 and 32 percent of
                         total EIC dollars claimed in 1999, or between $8.5 billion and $9.9 billion.



                         Page 9                                          GAO-03-794 Earned Income Credit
IRS also has some data on underclaims—instances where taxpayers
claimed less than they were entitled to receive. For tax year 1999,
underclaims were estimated to be between $710 million and $765 million.

IRS has conducted EIC compliance studies for several years and the
overclaim rate, which is the percentage of total dollars paid out in error,
was estimated to be about 24 percent in tax year 1994. According to IRS
officials, because different methodologies were used in the subsequent
studies, changes in estimated overclaims found in other studies do not
support conclusions about trends in the overclaim rate over time. However,
IRS officials also acknowledged the overclaim rate has not improved
significantly. Overclaim rates for tax years 1997 and 1999 are shown in table
2. The information in table 2 does not reflect the current compliance
situation; for example, it does not reflect the presumably positive impact of
new legislation that has taken effect since 1999 aimed at improving
compliance.



Table 2: EIC Overclaim Rates for 1997 and 1999

Tax year                                     Lower-bound rate                  Upper-bound rate
1997                                                       23.8%                             25.6%
1999                                                       27.0%                             31.7%
Source: IRS data.

Note: Because not all individuals responded to audit contacts, IRS uses certain assumptions to
estimate the overclaim rate range. The lower-bound rate assumes that the overclaim rate for the
nonrespondents is the same as for the respondents, while the upper-bound assumes that all
nonrespondents are overclaims.


Although IRS’s studies have shown high EIC overclaim rates for many
years, other studies had shown that EIC’s participation rate was fairly high.
For example, in 2001 we reported that an estimated three of every four
eligible participants received the EIC in tax year 1999.8 For taxpayers with
one or two qualifying children, we estimated that participation rates
exceeded 90 percent. Individuals with no children, who receive a much
smaller credit than taxpayers with qualifying children, had a much lower
participation rate that we estimated to be about 45 percent. Although at the
time we reported that available data did not enable us to determine the


8
 U.S. General Accounting Office, Earned Income Tax Credit Participation, GAO-02-290R
(Washington, D.C.: Dec. 14, 2001).




Page 10                                                       GAO-03-794 Earned Income Credit
                             reasons for these differences, IRS officials attributed these differences, in
                             part, to the lower EIC amounts allowed for individuals and because the
                             program did not include individuals without children when it first began.



Task Force Reviewed          The EIC task force reviewed whether recent statutory changes have the
Recent Legislative Changes   potential to reduce the major sources of EIC noncompliance, either by
                             changing the rules or providing IRS new enforcement options. Because the
Likely to Improve
                             study of tax year 1999 compliance was the most recent available, the task
Compliance                   force lacked data on the effect of the recent changes and relied on other
                             analyses that showed whether the changes would affect compliance. Of the
                             recent changes, the task force estimated that one change, to the Adjusted

                             Gross Income (AGI) tiebreaker rule,9 would likely reduce noncompliance.
                             The task force judged that the other legislative changes, including those
                             proposed by Treasury, while potentially helping reduce noncompliance
                             from other sources, would not be enough to reduce noncompliance
                             without further IRS efforts.

                             Three key pieces of legislation, which have been recently enacted or taken
                             effect, were at least partially aimed at improving EIC compliance, as shown
                             in table 3. They may eventually help reduce noncompliance after taxpayers
                             and tax preparers become familiar with the new laws. The statutory
                             changes were to serve several purposes, including improving compliance
                             and simplifying tax laws associated with the EIC.




                             9
                              The new AGI tiebreaker rule applies when two taxpayers can claim the same qualifying
                             child. If one of the taxpayers claiming the credit is the child’s parent (or parents who file a
                             joint return), then the child is considered the qualifying child of the parent or parents. If
                             both parents claim the child and parents do not file a joint return, then the child is
                             considered a qualifying child first of the parent with whom the child resided for the longest
                             period during the year, and second of the parent with the highest adjusted gross income. If
                             none of the taxpayers claiming the child as qualifying is the child’s parent, the child is
                             considered a qualifying child with respect to the taxpayer with the highest adjusted gross
                             income.




                             Page 11                                                    GAO-03-794 Earned Income Credit
Table 3: Recent Statutory Changes

Law                                    Change
Economic Growth and Tax Relief This act made several changes, including (a) effective
Reconciliation Act of 2001(P.L. for tax years after December 31, 2001, simplifying the
107-16, March 7, 2001)          “Adjusted Gross Income tiebreaker rule,” (b) for tax
                                years beginning after December 31, 2001, establishing
                                a new definition for earned income by eliminating non-
                                taxable earned income and by having the Earned
                                Income Credit (EIC) based on adjusted gross income,
                                (c) for tax years beginning after December 31, 2001,
                                amending the definition of a foster child by reducing
                                the residency requirement to over half a year, and
                                (d) effective January 1, 2004, allowing the IRS to use
                                math error authority to deny EIC claims if the Federal
                                Case Registry (FCR) indicates that the taxpayer is the
                                noncustodial parent of the qualifying child with whom
                                the credit is claimed.
Ticket to Work and Work                Effective after December 31, 1999, part of this act
Incentives Improvement Act of          simplified the definition of a foster child.
1999 (P.L. 106-170, December
17, 1999)
Tax Relief Act of 1997 (P.L. 105-      After October 1,1998, this act requires that each
34, August 5, 1997)                    record in the state registry include the Social Security
                                       number of any child for whom support has been
                                       ordered. This information is included in the FCR
                                       database. It also requires an applicant for a Social
                                       Security number who is under age 18 to provide his or
                                       her parent’s Social Security numbers, in addition to
                                       other required evidence, such as age, identity, and
                                       citizenship.
Source: GAO analysis of legislation.


A Treasury study showed that the change in the AGI tiebreaker rule
effective for tax years after December 31, 2001, would likely have
eliminated about $1.4 billion of the nearly $2 billion in tax year 1999 EIC
overclaims that were due to tiebreaker errors. Accordingly, the task force
decided that this source of EIC overclaims did not need to be further
addressed by a new compliance initiative.

Although officials recognized the benefits of these recent legislative
changes to help improve EIC compliance, they concluded that additional
initiatives were still needed. For example, officials recognized the value of
IRS being able to use math error authority to deny EIC claims on and after
January 1, 2004, when the Department of Health and Human Services’
Federal Case Registry (FCR) indicates that the taxpayer is the noncustodial
parent of the qualifying child. However, officials told us that this authority



Page 12                                                      GAO-03-794 Earned Income Credit
                           was limited and not applicable to a significant number of taxpayers whose
                           compliance may be problematic. IRS has a study in process to determine
                           the effectiveness of using FCR data to deny EIC claims using its math
                           authority. The study was scheduled for completion by July 30, 2003, but as
                           of August 20, 2003, was not yet completed.



Task Force Considered      The EIC task force considered three key options to verify taxpayers’
Three Alternatives to      qualifying children: (1) partnering with other federal or state agencies or
                           government programs to verify EIC taxpayers’ eligibility, (2) creating a
Improve Qualifying Child   federal database that would automatically match and detect questionable
Compliance                 or erroneous EIC claims, and (3) certifying taxpayers’ eligibility for certain
                           EIC criteria. Ultimately, in August 2002, the Secretary of the Treasury
                           approved the qualifying child certification program, which at the time was
                           to include providing proof of eligibility in advance of the filing season
                           (July–December), and was referred to as “precertification.”

                           The first two options were expected to impose little or no documentation
                           requirements on taxpayers. The task force was trying to determine for both
                           options whether sufficient information was already available from others,
                           or that little additional information would need to be collected by others, to
                           verify a taxpayer’s qualifying children. However, the task force found that
                           there was little overlap between the EIC population and verification
                           criteria used to administer other federal or state programs. In addition,
                           although some databases existed, the task force found that they could not
                           be used to effectively verify EIC eligibility, largely for the same reason.
                           Consequently, the task force judged that these options were not likely to be
                           useful in addressing EIC compliance problems. Similarly, the task force
                           also found that if a federal database were created to facilitate EIC
                           verification, IRS would have to gather the bulk of the information itself,
                           thus imposing a burden on taxpayers, which would also be costly and time-
                           consuming for IRS. The third option, which the task force selected,
                           required taxpayers to demonstrate EIC eligibility for certain criteria,
                           namely residency and relationship tests for qualifying children, prior to
                           receiving the credit.

                           The relative cost of the options the task force considered did not drive the
                           decision to select the qualifying child program because the other two
                           alternatives were not considered viable. The task force did compare IRS’s
                           EIC administrative costs to those of other federal benefit programs and
                           found them to be much smaller. IRS has had a special appropriation for EIC
                           compliance initiatives since 1998—and has received about $875 million



                           Page 13                                          GAO-03-794 Earned Income Credit
                             total through fiscal year 2003. It requested a total of about $250 million in
                             fiscal year 2004, which included $100 million for the EIC compliance
                             initiatives, including the qualifying child program, and about $150 million
                             for the special appropriation. IRS estimated that this $250 million10 total
                             was about 0.8 percent of the total annual EIC benefits distributed, and
                             therefore much smaller than the 9 to 13 percent administrative costs the
                             task force had found for other benefit programs. See appendix II for more
                             information we obtained on administrative costs for other benefit
                             programs.



Task Force Reviewed          The EIC task force reviewed IRS studies, other IRS data, and studies by
Studies and Data to Design   other parties to better understand the sources of EIC noncompliance and
                             devise new initiatives to address those known sources. In reviewing IRS
Initiatives Focused on       studies and data, the task force found that the three leading sources of EIC
Known Sources of             errors resulting in overclaims in 1999 were (1) claiming nonqualifying
Compliance Problems          children incorrectly, accounting for about $3 billion, (2) using the wrong
                             filing status, accounting for about $2 billion, and (3) misreporting income,
                             also accounting for about $2 billion. Three administrative proposals
                             resulted, involving (1) qualifying child certification, (2) improper filing
                             status, and (3) income misreporting.11 In 1999, another leading source of
                             EIC overclaims involved taxpayers with lower modified adjusted gross
                             income claiming a child when another person with a higher income should
                             have done so. The task force did not propose an initiative dealing with
                             these errors, primarily because the “AGI tiebreaker” legislation was
                             specifically enacted to decrease this source of noncompliance, as
                             previously discussed.




                             10
                              In addition to the $250 million that IRS requested in its fiscal year 2004 budget request to
                             administer the EIC, IRS incurs some additional costs. For example, IRS incurs costs to
                             process the EIC tax returns. Therefore, the full cost of administering the EIC is not known.
                             11
                               Improper filing status claims and income misreporting are other common problems
                             associated with the EIC. IRS plans to verify the filing status for about 41,650 cases in fiscal
                             year 2004, but the criteria for selecting the cases have not yet been finally determined. In
                             fiscal year 2004, IRS plans to use document matching to verify the income reported by about
                             300,000 EIC filers who have a history of misreporting income for 2 consecutive years in
                             order to increase (or receive) the EIC. Depending on how well these efforts work in fiscal
                             year 2004, they would be expanded in future years. Also see U.S. General Accounting
                             Office, May 20 Oversight Hearing on the Internal Revenue Service – Questions for the
                             Record, GAO-03-962R (Washington, D.C.: June 27, 2003).




                             Page 14                                                    GAO-03-794 Earned Income Credit
To deal with the error attributable to claiming children who are not EIC
qualifying children, the task force proposed a qualifying child certification
program. Based on analyses of past compliance data, IRS found that
taxpayers who overclaimed the EIC, most frequently claimed children who
did not meet the residency or relationship criteria.12 As a result, the task
force proposed the qualifying child program that was to include an annual
residency certification and a one-time relationship certification.

Under this program, during the period from July through December,
taxpayers would have been asked to document that the children they
intend to claim under the EIC, meet the EIC relationship and residency
criteria. The task force proposed targeting the program to those taxpayers
with qualifying children for whom IRS could not establish residency or
relationship through other available means and it proposed that this
concept be tested on a sample of EIC taxpayers for the tax year 2003. The
task force envisioned that ultimately all EIC claimants whose eligibility
could not be verified through available means would be asked to provide
additional eligibility documentation prior to the filing season. Taxpayers
who successfully certified qualifying children’s eligibility in advance of the
filing season would have their claims processed and paid expeditiously
during the filing season, absent any other problems with their tax return or
EIC claim. Having taxpayers certify between July and December was also
intended to allow IRS to process the taxpayers’ documents outside of the
filing season when IRS processing systems are in highest demand.
Taxpayers who did not respond and/or were unable to document their
eligibility during the certification period, but then claimed the EIC when
they submitted their tax returns, would have the EIC portion of their tax
refund frozen. Then they would be required to provide the same
documentation during or after the filing season as they were asked to
provide during the certification period. When and if they document their
eligibility, the EIC portion of their refunds would be released.




12
  For 2002 returns, taxpayers who claim the EIC with a qualifying child must meet certain
tests, including residency and relationship. To meet the residency test, the qualifying child
had to live with the taxpayer in the United States for more than half of the year. To meet the
relationship test, the qualifying child had to be a son, daughter, adopted child, stepchild of
the taxpayer, or a descendent of any such individual. Sisters, brothers, stepsisters,
stepbrothers, and descendents of any such individual also qualify if the taxpayer cares for
the individual as they would their own child. In addition, a foster child can qualify for the
relationship test if certain conditions are met. Internal Revenue Service, Earned Income
Credit (EIC), Publication 596 (Washington, D.C.: 2002).




Page 15                                                    GAO-03-794 Earned Income Credit
Process for Identifying         According IRS officials, as the task force neared its end and before the
Taxpayers When IRS Planned to   Secretary of the Treasury approved the program, IRS developed a means
Certify for Relationship        for using existing data to determine whether each taxpayer likely would
                                meet the relationship or residency test for children they had claimed for
                                EIC for tax year 2002. For relationship, IRS developed a plan to match
                                taxpayers to several databases that show the parents of children. For
                                instance, one database IRS planned to use was the Social Security
                                Administration’s database (which IRS refers to as KIDLINK) that ties
                                parent’s and children’s Social Security numbers for children born after 1998
                                in U.S. hospitals. For tax year 2003, IRS had planned to match 1.6 million,
                                or 10 percent of the approximately 16 million EIC taxpayers with a
                                qualifying child, to the databases. Under this scenario, any taxpayer who
                                was not shown to be the parent of a qualifying child claimed for tax year
                                2002 would then be part of the population from which IRS would randomly
                                select taxpayers to test for relationship.

Process for Identifying         IRS considered the work of the task force in developing a comparable
Taxpayers to Certify for        means for using available data to identify those who have met the residency
Residency                       criterion. The task force had analyzed data from the 1999 compliance
                                study and information in other reports.13 It found that residency errors
                                related to qualifying children were often correlated with the taxpayer’s
                                relationship to the child and the taxpayer’s filing status and gender. The
                                analysis showed that, overall, parents who filed married filing jointly were
                                the most compliant when compared to taxpayers filing single or head of
                                household in claiming a qualifying child who meets the residency test.
                                Married filing jointly parents had the fewest qualifying child residency
                                errors—1.5 percent—compared to any other combination of taxpayers by
                                relationship to the child, gender, or tax filing status. Among taxpayers who
                                file single or head of household, mothers were the most compliant (see
                                figure 1).




                                13
                                 Andrew J. Cherlin and Paula Fomby, “Welfare, Children, and Families: A Three-City Study,”
                                A Closer Look at Changes in Children’s Living Arrangements in Low-Income Families,
                                Working Paper 02-01(Baltimore, MD.: Johns Hopkins University, Feb. 20, 2002), and Allen
                                Dupree and Wendell Primus, Declining Share of Children Lived with Single Mothers in the
                                Late 1990s: Substantial Difference by Race and Income (Washington, D.C.: Center on
                                Budget and Policy Priorities, June 15, 2001). We did not review these studies in detail.
                                Instead, we relied upon IRS’s assessment.




                                Page 16                                                 GAO-03-794 Earned Income Credit
Figure 1: Estimated Percentage of EIC Taxpayers (with Children) Who Made
Residency Errors and Filed Single or Head of Household in Tax Year 1999
80 Percentage


70


60


50
                                              44.1

40
                                 33.9
30                    29.4


20


10
         3.4
 0    mothers         male      fathers     female
                    nonparent              nonparent
Source: IRS data.

Note: This figure reflects residency errors only. Mothers who filed as single or head of household, for
example, made qualifying child residency errors 3.4 percent of the time, while 96.6 percent of the time,
they either made no errors or errors other than residency-related errors.


The task force also found other reports that reinforced the results of its
analysis. Specifically, an independent study of low-income households in
three urban areas estimated that children resided with biological mothers
90 percent of the time. Another study estimated that 89 percent of children
in low-income households lived with both parents or their mother.

IRS used this information to propose a process for identifying taxpayers to
include in the population that would be subject to the residency
certification requirement. IRS proposed that the 1.6 million taxpayers, or
10 percent of the 16 million taxpayers with a qualifying child, would be
matched to the FCR database. IRS officials considered the FCR to be the
most useful database for identifying those meeting the residency
requirements. This database compiles court and other records that
indicate who is the custodian for a child (which could be a parent or
nonparent). IRS assumes that children live with the custodian of record.
According to IRS, the FCR database contains custodial information for
about 40 percent of the EIC population. If a taxpayer matched as the
custodian of the child claimed for the EIC for 2002, the taxpayer would not




Page 17                                                          GAO-03-794 Earned Income Credit
                         be among those needing to certify. When the FCR database showed
                         someone was the custodian of a child other than the EIC taxpayer who had
                         claimed that child for the EIC in 2002, those taxpayers would be among the
                         group from which the residency certification sample would be drawn.

                         When the FCR contains no information about the child a taxpayer had
                         claimed for EIC in 2002, the IRS would attempt to establish the relationship
                         of taxpayers to qualifying children by comparing information in several
                         databases. Those taxpayers IRS could identify from databases as the child’s
                         mother would be excluded from the sample, if they filed married filing
                         jointly, single, or as head of household. Mothers would be excluded on the
                         basis of the task force analyses showing mothers to be among the most
                         compliant on the residency criterion. Also excluded from the sample
                         would be fathers who filed as married filing jointly. Otherwise, all males
                         who were shown to be a child’s father filing single or head of household
                         would be included in the group from which the certification sample would
                         be drawn because of the data showing a high level of noncompliance on the
                         residency criterion for these taxpayers. Finally, all nonparents who are not
                         shown in the FCR to be the custodian would go into the group from which
                         taxpayers would be selected for residency certification, also due to
                         information showing nonparents to be among the less compliant taxpayers
                         on the residency criterion. The selection processes for relationship and
                         residency would have, therefore, yielded a group of taxpayers that would
                         include some needing to certify for relationship only, some for residency
                         only, and some to certify for both.



IRS Has Made Key         Since adopting the EIC task force recommendations in August 2002, IRS
                         has made key changes to the qualifying child certification program in
Changes to Its Initial   response to input received and additional analyses done. Some of these
Qualifying Child         changes include (1) postponing relationship certification for an
                         undetermined period of time, (2) delaying program implementation, and
Certification Program    (3) reducing the test sample from 45,000 to 25,000. However, these changes
and More May Occur       create additional challenges for IRS and taxpayers. Despite these
                         challenges, the process for selecting taxpayers, what taxpayers will receive
                         from IRS, and what taxpayers will be required to provide remains basically
                         the same as originally planned. According to officials, the same factors
                         were considered when setting the new sample size, which is still designed
                         to allow IRS to achieve the same goals as the original sample size, albeit to
                         a lesser extent.




                         Page 18                                         GAO-03-794 Earned Income Credit
                              In addition, IRS has emphasized that program expansions, if any, will
                              depend on the results of this year’s test. Concerns we identified in our
                              report on recertification14 were considered and taken into account by IRS
                              in designing the new qualifying child certification program.



IRS Broadly Adopted Task      IRS took the broad charge from the EIC task force and designed the
Force Recommendations in      qualifying child certification program. Its focus was to decrease the EIC
                              overclaim rate while striving to maintain the high rate of participation and
Its Initial Design of the
                              minimize taxpayer burden. Initially, IRS decided that the certification
Qualifying Child              program would involve
Certification Program
                              • testing of 45,000 taxpayers for both relationship and residency
                                beginning in July 2003, and

                              • immediately expanding the certification program for relationship to 2
                                million taxpayers in 2005 and to both relationship and residency in
                                substantial numbers in future years.

                              However, as IRS obtained input on the program, it modified these plans.



Certification for Residency   Since initially formulating plans for the qualifying child certification, IRS
Only Is to Begin in           has made multiple changes to the program. First, IRS postponed
                              relationship certification for an undetermined period for a number of
December 2003 for 25,000      reasons. IRS had developed a draft form for certifying relationships and
Taxpayers                     obtained input on the form from external and internal stakeholders. Some
                              stakeholders raised concerns about whether taxpayers would be able to
                              provide some of the types of documentation IRS planned to request, such
                              as marriage certificates, within the time envisioned. IRS officials said that
                              testing the relationship certification this year was postponed, in part,
                              because these concerns were unresolved. The officials also noted that
                              Treasury studies have shown relationship requirements to be a lesser
                              compliance issue than residency, and taxpayers that were found to be


                              14
                                The “certification” program is different from the IRS “recertification” program, which is
                              required by statute. Recertification was implemented in 1998 and requires taxpayers who
                              have been disallowed the EIC through an IRS examination to substantiate their qualification
                              for the EIC, i.e., recertify before they receive the credit again. U.S. General Accounting
                              Office, Opportunities to Make Recertification Program Less Confusing and More
                              Consistent, GAO-02-449 (Washington, D.C.: Apr. 25, 2002).




                              Page 19                                                  GAO-03-794 Earned Income Credit
noncompliant with relationship requirements were also often
noncompliant due to residency errors. Since both residency and
relationship requirements have to be met, if taxpayers fail certification on
residency there would be no need to test on relationship. Consequently,
officials gave a higher priority for testing residency certification.

Second, IRS has changed the start date of the test twice. Originally, IRS
planned to start the test in July 2003, but postponed implementation until
mid-August. As we were finalizing this report, IRS announced in August
that it now plans to begin the test in December 2003, in conjunction with
the 2004 tax filing season. (Appendix IV shows key milestones from 2002
through 2005.) According to IRS officials and documents, implementation
was postponed from July to August to allow time to conduct focus group
testing, request and obtain public comments during a 30-day period, and
make changes to the program as a result of those efforts. Thereafter, IRS
postponed implementation a second time from August to December to
ensure (1) taxpayers have better access to tax practitioners since many
only operate during the filing season and (2) more time for outreach and
education.

However, as a result of the delays, taxpayers will be providing proof of
residency documentation during the filing season and not “precertifying”
before the filing season as originally envisioned. This change is important
and creates additional challenges for both IRS and taxpayers, as follows:

• Taxpayers will no longer have the opportunity to provide proof of
  qualifying child residency, correspond with IRS in advance of the filing
  season, and resolve any potential issues before filing their tax returns.
  Because all correspondence will take place during the filing season,
  selected taxpayers could experience a delay in receiving the EIC portion
  of any refund, if the EIC portion is frozen because of any problems until
  certification is successfully completed.

• IRS will no longer be able to spread out its workload and processing
  may be slower since certification will occur during the filing season---
  IRS’s busiest time of year.

• IRS will not have the opportunity to assess taxpayers’ ease or difficulty
  in obtaining required documentation in advance of the filing season and
  whether taxpayers would do so. This is important because taxpayers
  may be given the opportunity to certify in advance of the filing season in
  future years.



Page 20                                         GAO-03-794 Earned Income Credit
                              Third, IRS reduced the number of taxpayers included in the test from
                              45,000 to 25,000, in part, in response to comments received during the 30-
                              day public period. According to IRS officials, despite reducing the number
                              of taxpayers included in the test, the sample size should still allow IRS to
                              make statistically valid measurements of results in addition to helping IRS
                              meet its desired goals of protecting revenue and testing the process for
                              conducting the certification program. In addition, the smaller sample
                              should help mitigate the challenge related to processing the certification
                              forms during the filing season.



Process for Selecting         Despite these changes, how IRS selected taxpayers for the test, what
Taxpayers, What They Will     taxpayers will receive from IRS, and what taxpayers will be asked to
                              provide as proof of residency for qualifying children will remain
Receive, and What They Will   fundamentally the same. IRS’s process for selecting the taxpayers for the
Provide to IRS Remains        test is shown in figure 2.15 Using this process, IRS selected 25,000
Basically the Same            taxpayers in August. The 25,000 represents about 0.16 percent of the
                              approximately 16 million EIC claimants with a qualifying child in tax year
                              2002 and about 0.13 percent of the approximately 20 million EIC recipients
                              overall.




                              15
                                IRS will exclude from its sample taxpayers who are subject to an examination,
                              investigation, or other treatment at the same time.




                              Page 21                                                 GAO-03-794 Earned Income Credit
Figure 2: IRS’s Process to Identify the Population of Taxpayers from Which the
25,000 Person Test Sample Was Drawn




Page 22                                             GAO-03-794 Earned Income Credit
no                                                                                                              Taxpayer was the child’s
       The taxpayer was not                                                                            yes
                                                                                                                father and filed single or
       the child’s custodian.
                                         Taxpayer was the                                                          head of household.
                                      child’s mother or father
                                                                                 Was IRS
                                      and filed married filing
                                                                                  able to
                                     jointly or was the child’s
                                                                  yes            establish
                                      mother and filed single
                                                                            that the taxpayer
                                      or head of household.b
                                                                               is the child’s
                                                                                  parent?
                                                                                                               Taxpayer was not the
      No information found in                                                                                     child’s parent.
      Federal Case Registry.                                                                            no
no
                                              STOP.
                                     Taxpayers not subject
                                           to test, but
                                      are subject to IRS’s
                                        regular process
                                         for determining
                                          EIC eligibility.
                                                                                                                 This is the population from which the test
   IRS attempted to establish                                                                                     sample was drawn. IRS estimated about
relationship of taxpayers to their                                                                               402,000 taxpayers remained at this point.c
      qualifying children by
 comparing information from the
    2002 tax year to various
   databases, such as Social
    Security Administration’s
            KIDLINK.
                                                                                                                            IRS selected 25,000
                                                                                                                             taxpayers for test.




                                                  a
                                                   The FCR contains custodial and welfare assistance data. If there is a match showing that the taxpayer
                                                  is the child’s custodian, regardless of the taxpayer’s gender, filing status, or relationship to the child,
                                                  IRS assumes the child resides with the taxpayer.
                                                  b
                                                   These taxpayers are excluded, based on (1) IRS compliance data that show married filing jointly
                                                  parents are 20 times more compliant on residency than nonparents, and single or head of household
                                                  mothers are 10 times more compliant on residency than single or head of household fathers and (2)




                                                  Page 23                                                             GAO-03-794 Earned Income Credit
private studies that show about 90 percent of children in low income households live with their mother
or both parents.
c
  IRS estimates that using the FCR and other databases will exclude almost 75 percent of the 1.6
million taxpayers. Therefore, about 402,000 taxpayers were included in the population from which IRS
drew the certification sample.


According to agency officials, IRS will now send the 25,000 taxpayers forms
and instructions about the program in December instead of this summer.
IRS plans to send Notice 84-A, a letter informing them about the new
program; Form 8836, “Qualifying Children Residency Statement;”
Publication 3211M, “Earned Income Tax Credit Question and Answers;”
and Publication 4134, “Free/Nominal Cost Assistance Available for Low
Income Taxpayers.” However, officials are changing these documents
based on the public comments received. Appendix V has the most current
copies of these documents.

Once taxpayers receive this information from IRS, they would obtain
documentation to prove the qualifying child’s residency and send it back to
IRS. IRS examiners would review the documentation and send a letter back
to the taxpayer either accepting or rejecting the claim, as shown in figure 3.



Figure 3: The EIC Certification Process as Envisioned




IRS currently envisions that the 25,000 taxpayers selected for certification
will be required to provide proof that the qualifying child meets residency
requirements before getting the EIC portion of their refund. IRS officials



Page 24                                                         GAO-03-794 Earned Income Credit
                          say that taxpayers who are able to establish eligibility when filing their tax
                          return should receive their refunds more expeditiously than those who do
                          not. Taxpayers selected for certification but who are not able to provide
                          the necessary documentation will be treated essentially the same as
                          taxpayers undergoing a correspondence audit. The EIC portion of their
                          refund—if they are to get one—will be frozen until proof of eligibility is
                          established.



Same Factors Considered   According to IRS’s draft evaluation plan for the certification test and our
When Setting Smaller      discussions with officials, three factors were considered in setting the
                          original sample size of 45,000: (1) show that certification would “protect
Sample Size
                          revenue,” (2) determine whether the test will succeed, and (3) test its
                          processes and systems. According to IRS officials, the smaller sample size
                          of 25,000 is designed to allow IRS to achieve the same goals as the original
                          sample size, albeit to a lesser extent.

                          One factor considered by IRS for the certification test was to stop as large
                          an amount of EIC overclaims due to ineligible qualifying children as
                          possible during the 2003 tax year. To determine how many taxpayers to
                          include in the certification test to achieve this goal, officials said they
                          determined the maximum number of staff that could be assigned to and
                          adequately supported by the planned central unit in Kansas City that would
                          be responsible for the certification program. Based on the maximum
                          number of staff that could be assigned and assumptions about how many
                          cases staff could handle, IRS calculated that 45,000 taxpayers could be
                          included in the test. IRS estimated that $114.5 million in protected revenues
                          could be realized from including 45,000 taxpayers in the test. Based on the
                          revised sample size of 25,000, IRS now estimates that $63.6 million in
                          protected revenues could be realized.

                          A second factor considered was to have a large enough sample to support
                          analyses of whether the test succeeds. For instance, IRS is interested in
                          how many taxpayers provide the information needed for IRS to determine
                          qualifying child eligibility, whether taxpayers in the sample population who
                          are actually qualified to claim the EIC do not do so with their 2003 tax
                          return and why, and whether taxpayers found the certification process
                          burdensome. IRS’s draft plan for evaluating the certification test notes that
                          the original 45,000 sample size was much larger than needed to obtain
                          statistically valid measures of test results. The draft plan indicated that a
                          sample size of about 3,600 taxpayers, which would have provided an
                          estimate at 95 percent confidence levels plus or minus 5 percent, was the



                          Page 25                                          GAO-03-794 Earned Income Credit
                          number of taxpayers needed for IRS to determine qualifying child
                          eligibility. According to the draft plan, the 45,000 sample size would allow
                          very precise estimates for the population as a whole and should provide
                          statistically valid information about sub-sets of claimants. Despite the
                          reduction to 25,000, IRS officials still believe that this sample size will allow
                          for precise estimates for the universe as a whole and smaller subsets as
                          well.

                          Finally, a third factor in selecting both the 45,000 and 25,000 sample sizes
                          was to have a large enough sample to test the processes and systems that
                          would be required if IRS were to expand certification in the coming year.
                          IRS had been preparing to work on approximately 25,000 certification
                          cases during the filing season under its original plan for 45,000 taxpayers.
                          It based the 25,000 on worst case assumptions about how many of the
                          45,000 would not opt to submit proof of eligibility in advance of the filing
                          season and, instead, would have submitted their documentation during the
                          filing season. In addition, for this goal, the draft plan preceded IRS’s
                          current thinking that the certification program likely will not be expanded
                          as rapidly next year, if expanded at all. However, according to IRS officials,
                          based on the number of cases IRS estimates can be worked on and what it
                          plans to achieve under this goal, the 25,000 sample size is appropriate to
                          help test the systems and processes.



Future Expansion of       Although IRS has consistently referred to the certification effort as a test,
Certification Program     officials recently have stressed this point. For example, officials have
                          recently referred to the efforts for this year as a “pilot or proof of concept.”
Depends on Test Results
                          Furthermore, as a result of the most recent changes, the program will no
                          longer take place in advance of the filing season, but instead, during the
                          filing season. IRS officials told us that it is unlikely that the certification
                          program will be expanded to cover 2 million claimants in the summer of
                          2004, as originally anticipated. Instead, IRS officials plan to assess the
                          program’s overall effectiveness and make any necessary modifications
                          before expanding it to additional EIC claimants in the future. Thus,
                          particularly in light of IRS’s most recent announcement and according to
                          IRS officials, the program may be expanded more slowly, if at all,
                          depending upon the evaluation results. Officials also said that test results
                          will contribute to a future decision about whether certification, if
                          continued, will precede the filing season or be part of the filing season as it
                          will be this year.




                          Page 26                                            GAO-03-794 Earned Income Credit
Input from Focus Groups      On the basis of stakeholder input, focus groups, and other input, IRS has
and Others Has Resulted in   made several changes to the planned certification test in addition to those
                             discussed previously. IRS held informal meetings with external and internal
Changes and May Result in    stakeholders, focus group meetings with taxpayers and paid preparers, and
More                         one-on-one interviews with third parties to share the certification letters,
                             forms, and/or instructions and obtain views on aspects of the new process.
                             In response, IRS took several actions, including revising the forms. As of
                             August 2003, IRS was evaluating comments received during the 30-day
                             public comment period, which IRS officials said may result in additional
                             changes.

                             IRS held several informal meetings with external and internal parties with
                             an interest in the qualifying child certification program. In March 2003, the
                             Stakeholder Partnership, Education, and Communication Organization16
                             and the National Taxpayer Advocate held four informal meetings with
                             various external stakeholders, such as representatives of the National
                             League of Cities, the Boston EIC Coalition, and the American Institute of
                             Certified Public Accountants. Similarly, IRS officials coordinated the
                             certification initiative with internal stakeholders, such as representatives
                             from the Compliance unit, Wage and Investment operating division, Small
                             Business/Self Employed (SB/SE) operating division, and Forms and
                             Publications unit. The purpose of these meetings was to discuss the EIC
                             certification proposal and share the drafts of the two new certification tax
                             forms—Form 8836, “Qualifying Children Residency Statement,” and Form
                             8856, “Qualifying Child Relationship Statement.” Officials told us they
                             received comments from these groups of stakeholders and revised and
                             improved the forms based on the feedback received. For example, for the
                             residency form IRS added a list of community-based organizations and a
                             list of acceptable third parties from which IRS would accept affidavits.

                             After incorporating the recommendations from these informal meetings,
                             officials said they felt comfortable with testing the Form 8836, its
                             instructions, and the accompanying letter in other ways, including focus
                             groups, one-on-one interviews, and a 30-day public comment period.17


                             16
                               The Stakeholder Partnership, Education, and Communication Organization is a unit with
                             IRS’s Wage and Investment operating division. Its role is to educate and assist taxpayers
                             before their returns are filed.
                             17
                              Before the focus groups commenced, IRS had decided to move forward only with the
                             residency certification.




                             Page 27                                                 GAO-03-794 Earned Income Credit
In June 2003, a contractor conducted nine focus groups, five with taxpayers
who claimed EIC in tax year 2002, and four with tax preparers who had
prepared returns for taxpayers claiming EIC. In addition to the focus
groups, the contractor also conducted nine one-on-one interviews with a
cross section of the third parties listed on Part IV of the Form 8836 (the
participants were landlords, employers, and child care providers). The goal
of the testing was to determine whether individuals understood the
documents and thought they could obtain the requested supporting
documents and whether the suggested third parties would be willing to sign
the affidavit.

The focus groups and interviews were held in Philadelphia, Chicago,
Dallas, and Los Angeles. These cities were selected because of their high
EIC population. The participants were selected using screening guidelines
developed by IRS in conjunction with the contractor. Taxpayers were
selected on the basis that they claimed the EIC for tax year 2002 with a
qualifying child. Similarly, preparers were selected on the basis that they
worked as a tax preparer on federal tax returns for 2002 and prepared tax
returns for clients claiming EIC with a qualifying child. Those selected for
one-on-one interviews represented a cross section of the types of
individuals IRS deemed credible to provide affidavit information about the
EIC claimant. In total, 816 people were contacted and 109 agreed to
participate in the focus group testing. Of the 109, 88 persons arrived for the
testing and 81 actually participated in the focus groups. For the one-on-one
interviews, 12 individuals were qualified to participate and 9 actually
participated in the interviews.18

Key IRS officials were on site during the focus groups and one-on-one
interviews to observe the participants’ comments. A variety of comments
were received and some changes were made. For example, IRS highlighted
where taxpayers and third parties were to sign the forms. Although the
contractor’s report of these meetings was not available before the public
comment period, IRS officials who attended the meetings concluded that
they had not received any feedback that would preclude moving forward
with getting comments from the public.



18
  According to IRS officials, approval from the Office of Management and Budget is required
in situations where the agency conducts interviews with more than nine private sector
participants. However, because conducting such interviews was suggested later in the
process and because OMB had been briefed on the development of the certification test, IRS
did not seek that approval.




Page 28                                                  GAO-03-794 Earned Income Credit
                             During the comment period, anyone could write or go to IRS’s Web site and
                             provide any comments or opinions about the qualifying child certification
                             program, including the form IRS expected to use and the data it planned to
                             request to prove eligibility. According to IRS, during the 30-day public
                             comment period, IRS received about 200 communications containing
                             comments. Any other comments about the certification program are due by
                             December 31, 2003. In addition, individuals can comment on the
                             certification process during the filing season until April 15, 2004. As of
                             August 2003, IRS officials were reviewing the comments received and
                             anticipated making additional changes to the forms and publications
                             shown in appendix V.



Our Concerns with IRS’s      IRS officials told us they considered the recommendations in our
Recertification Were         recertification report19 when planning their certification program. We agree
                             that our applicable recommendations have been considered. Whether the
Considered as IRS Designed
                             strategies IRS adopted to deal with the concerns that led to our
the Qualifying Child         recertification report recommendations are successful will not be known
Certification Program        until IRS evaluates the certification test.

                             Our recertification report described three aspects of the recertification
                             process that caused problems for taxpayers. Specifically,

                             • one form used for recertification was of questionable value to IRS and
                               another form was potentially confusing to taxpayers;

                             • taxpayers were asked to submit information that was difficult for them
                               to obtain or inconsistent with what many IRS examiners considered
                               acceptable; and

                             • IRS examiners’ inconsistent assessment of documentation submitted by
                               taxpayers could result in different recertification decisions for
                               taxpayers in similar circumstances.

                             IRS has taken steps to deal with all of these concerns in designing the
                             certification process. Regarding the problems with recertification forms,
                             the form that was of questionable value to IRS, which was essentially a
                             means for taxpayers to tell IRS that they wished to be considered for


                             19
                                  GAO-02-449.




                             Page 29                                         GAO-03-794 Earned Income Credit
recertification, is not applicable to the certification program. The other
recertification form told taxpayers what they had to submit to establish
their eligibility for the EIC. We found that this form could confuse
taxpayers into believing they had to show that a qualifying child was also
their dependent, a criterion not applicable to EIC eligibility. We also found
that the form provided insufficient guidance to taxpayers on what
information they needed to provide to prove that qualifying children met
the EIC eligibility requirements. We made several recommendations,
including that IRS should clarify taxpayers do not need to demonstrate that
qualifying children are also dependents, help taxpayers better understand
what documentation they need to provide to establish their relationship
with any qualifying children, eliminate a requirement that statements from
child care providers be notarized, and encourage taxpayers to submit more
than one type of documentation.

Regarding our concerns about taxpayers who were recertifying being
asked to submit documentation that was difficult for them to obtain and
that tax examiners did not all accept, we found, for example, that EIC
taxpayers’ living arrangements could make providing various documents
difficult. We also found taxpayers did not always understand that school
records were for a calendar year and therefore needed to cover the spring
and fall of separate school years. We also found situations in which IRS
examiners would not accept a document even though the recertification
form listed the document as being acceptable. This concern overlapped
with our finding that IRS examiners’ were inconsistent in their assessment
of whether documentation provided by the taxpayers was sufficient to
establish their qualifications for the EIC.

Regarding our concerns about inconsistent documentation, IRS again took
actions intended to deal with our concerns in developing the certification
program. By introducing a new option—obtaining an affidavit affirming
that a qualifying child resided with the taxpayer for more than half the
year—IRS intended to give taxpayers another means of showing that the
residency requirement is met, which would prevent the taxpayer having to
obtain the other types of documents that the draft certification form lists.
Although IRS did not, as we recommended, create a new form to be used by
taxpayers when seeking school records, it did follow our alternative
recommendation that IRS clearly remind taxpayers that they need records
for part of 2 school years. The information is included in the certification
form’s instructions, which contain an example where a taxpayer must
provide records from 2 school years. Finally, by centralizing the EIC
certification processing in one location—Kansas City—and providing



Page 30                                         GAO-03-794 Earned Income Credit
                         training to those who will be involved, IRS is seeking to ensure a higher
                         level of consistency in how tax examiners judge whether taxpayers
                         adequately establish that qualifying children meet the residency criterion
                         for EIC.

                         Whether the manner in which IRS took our recertification
                         recommendations into account when designing the certification program
                         will be successful will not be known until IRS evaluates the certification
                         test.



Qualifying Child         The certification program appears to be adequately developed to
                         potentially improve EIC compliance with consideration for minimizing
Certification Program    taxpayer burden so that testing should proceed, particularly in light of IRS’s
Developed to Improve     recent announcement further delaying the program’s start and reducing the
                         sample size. For example, the EIC task force and IRS have taken steps that
Compliance While         directly minimized the number of taxpayers who will be burdened by the
Considering Taxpayers’   certification program. That is, the certification proposal is based on
Burden, but Plan for     analyses of the leading sources of EIC errors detected in earlier studies,
                         thus focusing attention and burden on the subset of taxpayers making
Evaluating Test Is       those errors, as opposed to all EIC recipients. In addition, IRS has taken
Incomplete               steps to address the burden taxpayers will experience as participants in the
                         certification test this year.

                         Although IRS has made and is continuing to make progress in defining its
                         plan to evaluate the certification test, the plan is incomplete. For example,
                         the draft plan does not indicate how and when some information that will
                         be needed to evaluate whether certification achieves its objectives will be
                         obtained and analyzed. However, officials recognize the draft plan needs to
                         be further developed and the importance of doing so quickly.



Initial Design and       In initially designing and subsequently modifying the EIC certification
Subsequent Changes May   program, officials took into account the burden that taxpayers may
                         experience while attempting to improve compliance. Officials designed the
Improve EIC Compliance
                         program to include, and thus burden, only the taxpayers most likely to
and Have Helped to       make the errors that contribute most to the EIC’s overclaim rate. By
Minimize Burden          focusing on these noncompliant taxpayers, IRS expects to improve EIC
                         compliance. In addition, officials took a number of steps, such as obtaining
                         input from external and internal stakeholders that resulted in changes and
                         delaying the program while considering comments received during the



                         Page 31                                          GAO-03-794 Earned Income Credit
comment period, which should reduce the burden on those taxpayers who
are identified to certify.

To help improve compliance, the task force focused on known sources of
noncompliance including claiming nonqualifying children, filing status, and
misreporting income. To deal with errors attributable to claiming
nonqualifying children, the task force proposed a program for certifying the
eligibility for qualifying children and envisioned targeting taxpayers most
likely to make those errors. In contrast, other benefit programs that we
reviewed generally require all applicants to provide documentation before
receiving assistance. For example, to receive Supplemental Security
Income, an individual must visit a Social Security office, meet with a
representative, and provide documentation including birth certificates and
payroll information. The Social Security Administration then matches this
information to determine eligibility in advance of benefits being received.
IRS’s certification effort, even if fully implemented, would require only a
subset of all EIC taxpayers to provide documentation to support their
eligibility and only when IRS is unable to verify eligibility from other
sources of information.

After the proposal was formally adopted, IRS took a number of steps in
developing plans for implementation that have been intended at least in
part to minimize the burden that taxpayers actually asked to certify would
experience, including the following.

• IRS has undertaken more activities than usual to ensure the residency
  form and other explanatory documents related to the certification
  program have been reviewed by those who would use them. 20 IRS
  sought feedback from focus groups and stakeholders on various aspects
  of the certification test and the draft letter, form, and instruction
  proposed for the residency test, such as whether taxpayers will be able
  to obtain and provide documents within the time available, and made
  some changes to the proposed form due to that feedback. As previously
  described, IRS held focus groups with taxpayers, paid tax preparers, and
  other parties to obtain feedback on certification. Officials also
  interviewed a small number of third parties who would be called upon


20
  IRS generally tests few forms and instructions with taxpayers before using them. See U.S.
General Accounting Office, Tax Administration: IRS Should Reassess the Level of
Resources for Testing Forms and Instructions, GAO-03-486 (Washington, D.C.: Apr. 11,
2003).




Page 32                                                  GAO-03-794 Earned Income Credit
      to provide requested documents. IRS also held a 30-day open period to
      receive comments from any interested party and expects to revise
      certification materials due to comments received. Finally, IRS officials
      say they will again revisit, among other things, the appropriateness of
      the forms and explanations going to taxpayers after evaluating the
      results of this year’s test of certification.

• IRS considered the issues we raised in our report about the
  recertification program21 when planning for certification. For example,
  as discussed previously in this report, IRS developed a standard form
  that includes an affidavit, which taxpayers can provide to third parties,
  such as an employer, as an alternative to obtaining other documents to
  prove residency. We also noted in our report that examiners
  inconsistently accepted or declined supporting documentation for
  recertification purposes. To address this concern, IRS officials
  conducted special training and have all certification examiners in one
  location, Kansas City, where EIC claims will be processed.

• IRS provided taxpayers with a variety of documentation choices in
  order to prove eligibility for their qualifying children. To certify for
  residency, taxpayers will need to provide Form 8836, “Qualifying
  Children Residency Statement,” with one or more of the following
  supporting documents:

      • school records, medical records, day care provider records, leases, or
        social service agency records that show the parent’s name and the
        child’s name and address, and the dates that the child lived with the
        parent; or

      • a letter on official letterhead for a qualifying child from the child’s
        school, health care provider, landlord, or member of the clergy that
        shows the parent’s name and the child’s name and address, and dates
        that the child lived with the parent; or

      • a third party affidavit from a clergy member, community-based
        organization official, health care provider, landlord or property
        manager, school official, or day-care provider.




21
     GAO-02-449.




Page 33                                           GAO-03-794 Earned Income Credit
                                • IRS dropped for an undetermined period of time, its plan to ask
                                  taxpayers to certify their relationship to qualifying children. IRS officials
                                  do not know whether or if they will test certification of relationships in
                                  the future. Various external stakeholders had expressed concerns about
                                  whether taxpayers would be able to provide the type of documents,
                                  such as marriage and birth certificates, which IRS had planned to
                                  request to document relationships to qualifying children on time. Also,
                                  IRS officials said that the relationship portion of the program was
                                  dropped for other reasons, including that (1) studies that have shown
                                  relationship requirements to be less of a compliance issue than
                                  residency and (2) taxpayers found to be noncompliant because of
                                  relationship requirements often were also noncompliant due to
                                  residency errors. As a result, certification will only include residency
                                  this year.

                                   As part of its effort to balance burden with ensuring compliance, IRS
                                   made the changes listed above. As we drafted this report, it had not yet
                                   determined what additional changes it would make to the forms on the
                                   basis of comments received during the 30-day public comment period,
                                   but officials said more changes will likely result. As previously
                                   discussed, the initial design of the residency form was responsive to
                                   concerns we raised in our earlier report on IRS’s recertification
                                   program. Additional changes, especially dropping relationship
                                   recertification, were responsive to the concerns that stakeholders
                                   raised before the public comment period. Accordingly, the current draft
                                   residency certification form addresses many burden concerns.



IRS’s Plan for Evaluating the   Although IRS has made and is continuing to make progress in defining its
Test Is Incomplete              plan to evaluate the certification test, the plan is not yet complete. From its
                                inception, the certification program was intended to: (1) reduce the EIC’s
                                overclaim rate, (2) minimize burden on taxpayers and (3) maintain the
                                EIC’s relatively high participation rate. Although there are many ways to
                                organize an evaluation, determining whether the major objectives of a
                                program are accomplished should help policymakers determine whether
                                and how to proceed with the program. The draft plan is not explicitly
                                organized to show whether certification’s objectives are achieved, but does
                                present some information on how IRS would evaluate these objectives.
                                However, the plan proposed potential options for identifying how and
                                when some critical data will be obtained and analyzed, but does not
                                provide further details on when decisions will be made on specific data that
                                will be collected, how, and by whom. Officials recognize that the draft plan



                                Page 34                                          GAO-03-794 Earned Income Credit
needs to be further developed and the importance of doing so quickly.
They have, for instance, developed preliminary drafts identifying additional
data needed and have begun considering how to use contractors to gather
the data. Because evaluating these objectives will depend in part on actions
of EIC certification participants that will now occur as part of next year’s
filing season, IRS appears to have some time before it must make final
decisions on how it will determine whether the objectives were met.

Although an evaluation plan may not have to completely identify all issues
that need to be evaluated and precisely how they will be evaluated before a
program begins, the more completely such a plan is developed before a
program is implemented, the more likely that the evaluation will be
sufficient to support future decisions. For example, identifying key
questions that need to be answered before a project’s implementation
increases the chances that necessary data will be collected to answer those
questions. IRS’s Internal Revenue Manual22 recognizes the desirability of
having evaluation plans in place before a project is implemented. For
instance, it requires such plans before reorganizations.

IRS has been preparing an evaluation plan for the certification test and has
a draft plan, dated April 22, 2003. That draft describes how IRS expects to
evaluate the program and the process IRS used to select taxpayers for the
test.

The draft plan identifies one “threshold” question for evaluating the
certification program: whether the claimant selected for the test provided
the required information to allow IRS to determine the eligibility of
qualifying children regardless of whether the claimant was determined to
be eligible or not. The plan lists data that are to be gathered throughout the
certification program to answer this question.

The threshold question is part of what must be included in determining
whether certification for residency helps lower EIC overclaims, but
additional information is needed. Although not tying methodologies or
planned data collection specifically to whether certification lowers the EIC
overclaim rate, the draft plan has a combination of approaches that should
contribute to answering this question. For example, the draft plan
identified data that IRS would gather throughout the test on how many
taxpayers in the test sample certify or fail to do so in advance of the filing


22
     See Internal Revenue Manual 1.1.4 and 1.2.1.




Page 35                                             GAO-03-794 Earned Income Credit
season as well as how many prove that children meet the EIC residency
test during the filing season.23

The extent to which certification may reduce overclaims due to qualifying
children not meeting the residency requirement, however, will depend
significantly on why some taxpayers will not attempt to certify and why
some will fail to claim the EIC, or as much EIC, for tax year 2003 as they
did for 2002. The draft plan takes into account that some taxpayers may
receive the certification materials, determine that a child does not meet the
residency test, and therefore not attempt to certify and not claim the EIC
with their 2003 tax return or claim EIC on another basis. IRS expects to use
available data to help assess whether the taxpayer had a filing requirement
and whether the taxpayer may have been eligible to claim the EIC (e.g., did
the taxpayer’s income fall within the appropriate range?). In addition, the
draft plan proposes that IRS use a contractor or another third party to
gather information from taxpayers about why they did not claim the EIC. A
subsequent document cites ideas for the types of questions that could be
asked.

Regarding the burden certification imposes on taxpayers who participate,
the plan is not organized to show how this will be evaluated, but it
recognizes that participants’ burden should be evaluated. For example, the
data IRS plans to collect throughout the process will have some utility in
answering this question. IRS will keep track of the number of
communications back and forth between IRS and the taxpayer before a tax
examiner makes a final certification decision. IRS’s plan also recognizes
that some information on burden will need to be collected directly from
taxpayers. The plan includes a general description of a potential opinion
survey that would gather burden-related information from certification
participants. Little or no detail is provided on how taxpayers would be
selected for such a survey, what types of questions would be asked, and
when the survey would be done; however, some of this information is
shown in a subsequent draft document. Because taxpayers will not have
completed their certification experience until sometime next filing season,
IRS has some time to decide whether to do such a survey and how to define
its parameters.




23
 IRS’s draft evaluation plan preceded its decision to test certification during the 2004 filing
season. These data will now need to be collected during the filing season.




Page 36                                                     GAO-03-794 Earned Income Credit
Regarding the objective of maintaining the EIC’s relatively high
participation rate, the draft plan proposes to obtain information from those
taxpayers who are asked to certify, do not, and then fail to claim the EIC.
The plan proposes to use a contractor or other third party to gather
information from these taxpayers about why they did not claim the EIC.
The plan does not amply describe how and when final decisions would be
made about selecting contractors or another third party to do this, when
the contractor would contact taxpayers, or what data they would attempt
to obtain from the taxpayers. Because the population IRS will need to
contact for these surveys will not be known until during and after the
spring of 2004, IRS has a number of months to further develop and
implement an approach.

Recognizing that its plans need to be further developed, IRS officials have
continued to explore how the evaluation will be done. For example,
officials have drafted ideas for the type of survey questions a contractor or
other party would ask of EIC taxpayers to help IRS assess why taxpayers
take, or do not take, various actions (such as why they may stop claiming
the EIC after being asked to certify eligibility) and to assess taxpayers’
experiences under the certification program, including the burdens they
experience. In addition, officials have begun identifying potential
contractors who would perform the surveys and considering contracting
options. According to IRS officials and documents, some discussions have
been held with potential contractors to gain a better understanding of ways
to test the survey instruments, techniques available to ensure the best
possible response rate, and the number of taxpayers needing to be
contacted to have useful results.

Finally, because IRS would like to undertake some version of the qualifying
child program next year, possibly including certification during the latter
part of 2004, the timely production of evaluative data for this year’s test will
be critical for supporting decisions about what form future efforts will
take. IRS is aware of the tight schedule. Officials note that while they will
not have complete information on which to base some decisions about
whether and how to continue with implementation in 2004 before those
decisions must be made, they expect to have preliminary data in a timely
fashion. For example, IRS will not be able to completely answer whether,
and if so, why, taxpayers who are legitimately qualified to receive the EIC
do not claim it when they file their 2003 tax return until the end of the 2003
tax filing season, or later if taxpayers request a filing extension. IRS does
expect that its contractor will have contacted many, if not most, of the
taxpayers who file returns before the end of the filing season and do not



Page 37                                           GAO-03-794 Earned Income Credit
                      claim EIC. Thus, IRS expects to know during the fall of 2004 why many
                      taxpayers in the certification test stop claiming the EIC.



Some Implementation   We did not evaluate some implementation issues because they were
Issues Not Reviewed   outside the scope of our review, still under development, or the Treasury
                      Inspector General for Tax Administration had audits planned in these
                      areas. Nonetheless, implementation issues could affect whether IRS is able
                      to fully implement the certification test and ultimately improve
                      compliance. We did not assess (1) whether IRS assigned an appropriate
                      number of staff to assist taxpayers with questions and process the forms
                      and documents relating to certification, (2) the adequacy of training
                      materials for staff or the procedures put in place to help examiners
                      consistently accept or decline taxpayers’ supporting documentation,
                      (3) the design or reliability of the databases that will be used to capture and
                      evaluate program information, and (4) supporting tools, which examiners
                      will use to do their job.

                      IRS has developed broad plans for processing the certification workload.
                      Officials identified about 30 different offices that will be affected by the
                      new certification program. As a key part of its processing strategy, IRS
                      plans to dedicate employees at its Kansas City campus to process cases,
                      answer a special toll-free number, and make updates to a certification
                      database based on responses from the test of the 25,000 taxpayers. The
                      Kansas City site will have about 180 staff, the bulk of whom will come on-
                      board between September and December 2003. Approximately 40 staff
                      took initial training between April and June 2003.



Conclusions           Given the persistently high EIC overclaim rates, that the certification
                      program is a test, and that IRS has taken key steps to address burden issues
                      and focus the test on individuals least likely to meet the qualifying child
                      residency requirements, we believe IRS has struck a reasonable balance
                      between preventing unreasonable burden on EIC taxpayers and balancing
                      the need to obtain information on whether certification can be a useful
                      approach to improving EIC compliance. In addition, with the recent
                      program changes announced in August, it appears that IRS is taking even
                      more steps to be mindful of these concerns. Although certification during
                      the 2004 filing season gives IRS somewhat more time to modify the forms
                      and take other actions to potentially further reduce the burden on
                      taxpayers subject to the test, it also creates new challenges for IRS. The



                      Page 38                                          GAO-03-794 Earned Income Credit
                      test will no longer be a direct test of the original concept of certifying
                      taxpayer eligibility in advance of the filing season. Instead, testing will
                      occur during the filing season—IRS’s busiest time of year—and gives IRS
                      only indirect evidence on how well certification may work before the filing
                      season as originally envisioned. Further, because IRS currently plans for
                      taxpayers to have to successfully provide proof of eligibility when they file
                      their individual income tax return or have a refund frozen until they do, a
                      greater portion of the taxpayers chosen for the test may have their refunds
                      delayed than if certification had been done before the filing season. Finally,
                      like virtually all aspects of the qualifying child certification program, IRS’s
                      future plans have yet to be determined and are largely dependent of the
                      results and subsequent evaluations of this test.

                      For various reasons, we did not review in detail some implementation
                      issues, such as staffing and procedures for handling taxpayer responses,
                      which could affect whether IRS is able to successfully implement the
                      certification test. Thus, our opinion on whether IRS is ready to proceed is
                      based only on whether it has adequately developed the test to prevent
                      unreasonable burden and to improve compliance.

                      Although the balance IRS has struck supports proceeding with the test,
                      IRS’s plan for evaluating the certification program test is incomplete. IRS
                      recognizes the need to evaluate the test and is developing its plan to do so.
                      For some key test objectives, IRS has preliminarily identified some data
                      that it believes must be collected to determine whether certification’s
                      objectives are achieved and has broadly identified when and how that
                      information will be collected. Because the data are related to taxpayers’
                      actions that will occur later this year or next spring, IRS appears to have
                      some time to finalize its evaluation plan.



Recommendations for   Given that the qualifying child certification program is a key part of IRS’s
                      plans for reducing EIC overclaims and that certification is intended to help
Executive Action      reduce overclaims while minimizing the burden on taxpayers and
                      maintaining the EIC’s participation rate, the Commissioner of Internal
                      Revenue should, to the extent possible, accelerate development of the
                      evaluation plan for the test. The plan should demonstrate how each of the
                      certification’s objectives will be evaluated, including milestones for such
                      critical steps as defining the specific data that will be collected, who will
                      collect the data, and how the data will be analyzed in time to support
                      decisions about the future of the program.




                      Page 39                                          GAO-03-794 Earned Income Credit
Agency Comments and   While not explicitly agreeing with our recommendation, in his September
                      22, 2003, letter, the Commissioner of Internal Revenue said that IRS would
Our Evaluation        be including the components we suggested in their evaluation plan and said
                      that IRS is working to incorporate these components well before the
                      certification test begins. The Commissioner said that our discussion of the
                      evaluation plan is essentially accurate, but provided an enclosure to his
                      letter that noted supplemental information on the plan. We are aware of the
                      information described in the enclosure to the Commissioner’s letter, and
                      considered it when drafting our report.

                      The Commissioner also raised concerns about the comparability of EIC
                      error rates to the error rates in taxpayers’ reporting of certain types of
                      income. We concurred that, by-and-large, the compliance data on reporting
                      of these types of income are not comparable to the EIC error rate. As a
                      result, we no longer show those comparisons in our final report.


                      We are sending copies of this report to the Chairmen and Ranking Minority
                      Members of the Senate Committee on Finance and the House Committee
                      on Ways and Means. We are also sending copies to the Secretary of the
                      Treasury; the Commissioner of Internal Revenue; the Director, Office of
                      Management and Budget; and other interested parties. We will make copies
                      available to others on request. In addition, the report will be available at no
                      charge on the GAO Web site at http://www.gao.gov.

                      This report was prepared under the direction of Joanna Stamatiades,
                      Assistant Director. Other major contributors are acknowledged in
                      appendix VII. If you have any questions about this report, contact Ms.
                      Stamatiades at (404) 679-1900 or me on (202) 512-9110.




                      Michael Brostek
                      Director, Tax Issues




                      Page 40                                          GAO-03-794 Earned Income Credit
Appendix I

Significant Noncompliance Rates Other Than                                                               Appendx
                                                                                                               ies




for the EIC                                                                                               Append
                                                                                                               x
                                                                                                               Ii




              The IRS has compliance data on some taxpayer groups such as individuals
              and small businesses and some tax items such as income and credits. By-
              and-large, the compliance data IRS currently has are not comparable to the
              EIC. IRS is implementing its National Research Program (NRP), which will
              provide new compliance data in 2004. In the meantime, IRS is using its
              Strategic Planning and Performance Management process to prioritize
              compliance issues.

              The compliance data that IRS has available for some taxpayer groups and
              tax items are largely based on the Taxpayer Compliance Measurement
              Program (TCMP),1 which was last conducted in 1988. However, these data
              cannot be compared to the EIC overclaim or error rates, in part because
              these data are 15 or more years old and reliable inferences cannot be drawn
              because much of the tax system and the economy have changed during that
              time. In addition, the methods used to calculate compliance rates for TCMP
              are different than those used to calculate EIC.

              In late 2002, IRS began implementing its new NRP, a detailed study of
              individual taxpayers’ compliance.2 As part of NRP, IRS has identified a
              random sample of approximately 47,000 returns from tax year 2001 and is
              in the process of verifying the information on the returns through reviews
              of IRS and third-party data. Where necessary to confirm the accuracy of
              taxpayer-reported information, IRS is conducting either correspondence or
              face-to-face examinations. IRS intends to conduct additional NRP reviews
              of additional types of taxpayers, such as small corporations, and use the
              NRP periodically to measure compliance of individual taxpayers.

              The NRP sample of 47,000 returns includes about 7,300 EIC returns. These
              EIC returns are subject to the same processes as the other returns in the
              sample, and will include a review of the taxpayers’ eligibility for the EIC. In
              order to determine whether the NRP review of these returns will yield
              results methodologically similar to those of the 1999 EIC compliance study,
              IRS is also comparing the results of the 1999 compliance study with NRP by
              putting a sample of returns from the 1999 study through NRP processes


              1
               For almost 30 years, the Taxpayer Compliance Measurement Program was IRS’s method for
              statistically estimating the voluntary compliance of taxpayers in reporting their tax
              obligations.
              2
               Among other things, IRS plans to use NRP data to update the formulas used to select tax
              returns for examination and allow it to design programs that will help taxpayers comply
              with tax laws.




              Page 41                                                 GAO-03-794 Earned Income Credit
Appendix I
Significant Noncompliance Rates Other Than
for the EIC




(not including examinations). According to IRS officials, this should allow
them to see the impact of the methodological differences between the
compliance study and NRP review. IRS expects the results of the
comparison study by September 2003. IRS plans to have preliminary NRP
results in May 2004 and final results in November 2004.

Until better compliance measurement data are available, IRS’s
organizational divisions use the Strategic Planning Budgeting and
Performance Management process to prioritize the compliance problems
IRS faces. Through this process, IRS says that it (1) identifies and explores
critical trends, issues, and problems, (2) develops operational priorities
and improvement projects to address existing or emerging problems,
(3) explores drivers of program resources in order to develop resource
allocation targets for carrying out the proposed strategies, and (4) enables
division commissioners and the senior leadership teams to prioritize the
strategies and projects and determine the resource requirements to apply
to each strategy, operational priority, and improvement project.

Based on managers’ judgments made during this process, the Small
Business/Self Employed (SB/SE) operating division, for example, identified
its top six compliance priorities for fiscal year 2003 and 2004:

• high income nonfilers (income greater than $100,000),

• abusive offshore financial transactions,

• promoter investigations (those selling tax schemes to others),

• abusive tax avoidance transactions,

• high income taxpayers (income greater than $1 million), and

• returns with a high probability of unreported income.

SB/SE, which conducts few examinations of EIC claims, did not consider
EIC in this prioritization exercise since EIC has its own dedicated
appropriation.3 Because IRS used different means to identify and prioritize
these potentially noncompliant taxpayer groups, their identification as


3
 Personnel in IRS’s Wage and Investment operating division conduct the majority of EIC
examinations.




Page 42                                                 GAO-03-794 Earned Income Credit
Appendix I
Significant Noncompliance Rates Other Than
for the EIC




SB/SE priorities does not mean their noncompliance rate is comparable to
noncompliance rates established for EIC or rates, which will be determined
through the current or future NRPs or other EIC compliance studies.




Page 43                                       GAO-03-794 Earned Income Credit
Appendix II

Overclaim Rates, Administrative Costs, and
Eligibility Verification Processes of Benefit
Programs                                                                                                    Appendx
                                                                                                                  Ii




                In addition to the data we complied on IRS’s EIC and qualifying child
                certification program, we also compiled overclaim rate and administrative
                cost data, as well as information on the eligibility verification processes, for
                nine other federal or state benefit programs. We selected the nine benefit
                programs because each requires some type of certification for benefits,
                similar to the EIC, and because the EIC task force reviewed the same
                programs. We did not do a comprehensive analysis to determine which
                programs, if any, are most comparable to the EIC, nor did we determine
                whether the information reported is comparable across programs.

                The overclaim rates, administrative costs, and the eligibility verification
                processes for the EIC and the other nine benefit programs—-
                Unemployment Insurance, Supplemental Security Income, Social Security
                Disability Insurance, the National School Lunch program, the Food Stamp
                program, Housing and Urban Development rental assistance, Medicaid,
                Medicare, and Temporary Assistance for Needy Families—-are shown in
                table 4.

                Overclaim rates for programs other than the EIC for which data were
                available ranged from 0.2 to 10.7 percent. These overclaim rates reflect the
                percentage of total dollars paid out in error, not, for example, the
                percentage of claimants who made errors.1 To calculate the overclaim
                rates, most of the nine agencies selected a sample of program participants
                and conducted a detailed analysis of the cases. This can involve collection
                of additional supporting documentation, personal contacts with employers
                and other third parties, or home visits to program recipients. A description
                of how the overclaim rates were calculated is in table 5.

                Administrative costs range from $123 million to $11.9 billion for the nine
                programs. Administrative costs reported by federal agencies are likely not
                comparable across programs and may not include all of the costs involved
                in administering the programs. For example, various agencies and entities
                at the federal, state, and local levels have administrative responsibilities
                under the National School Lunch program. However, while the federal
                budget provides funds separate from program dollars to pay for
                administrative processes at the federal and state level, officials at the local




                1
                 We use the term overclaim rate to be the total excess payments made in error. This is
                generally referred to as the error or overpayment rate in the other programs we reviewed.




                Page 44                                                 GAO-03-794 Earned Income Credit
                                             Appendix II
                                             Overclaim Rates, Administrative Costs, and
                                             Eligibility Verification Processes of Benefit
                                             Programs




                                             level pay for administrative costs from program dollars that include federal
                                             and state funding and student meal payments.2

                                             The process used to determine and validate eligibility varies significantly.
                                             Some programs, such as the school lunch program, rely primarily on self-
                                             reported information and verification is limited. Other programs, such as
                                             the Food Stamp program, require program staff to conduct extensive
                                             verification.



Table 4: Overclaim Rates, Administrative Costs, and Eligibility Verification Processes for EIC and Other Programs

Program              Overclaim ratea      Administrative cost          Eligibility verification process
                                                       b
Earned Income Credit 27–32 percent        $145 million                 Currently, no certification requirement exists. An EIC claimant’s
                     (tax year 1999)      (tax year 1999)              return is selected for examination when it meets certain
                                                                       selection criteria that points to potential overclaim. When this
                                                                       occurs, documentation is generally requested to establish
                                                                       requirements for EIC and related issues using document
                                                                       request forms including for qualifying child, filing status, and
                                                                       dependency issues.
Unemployment         8 percentc           $2.3 billiond                Eligibility for unemployment insurance benefits is determined
Insurance            (fiscal year 2001)   (fiscal year 2001)           under state law, so the information applicants are required to
                                                                       provide varies by state. States rely heavily on self-reported
                                                                       information; in some states applicants can apply over the
                                                                       telephone or on-line. Only a limited number of states
                                                                       independently verify claimants’ identity by using the Social
                                                                       Security Administration’s State Online Query system, which can
                                                                       match a claimant’s name, date of birth, and Social Security
                                                                       number. States may use independent automated data sources
                                                                       to verify other eligibility factors such as wages and employment
                                                                       status.




                                             2
                                              See, for example, U.S. General Accounting Office, School Meal Programs: Estimated Costs
                                             for Three Administrative Processes at Selected Locations, GAO-02-944 (Washington, D.C.:
                                             Sept. 25, 2002).




                                             Page 45                                                   GAO-03-794 Earned Income Credit
                                               Appendix II
                                               Overclaim Rates, Administrative Costs, and
                                               Eligibility Verification Processes of Benefit
                                               Programs




(Continued From Previous Page)
Program                Overclaim ratea      Administrative cost          Eligibility verification process
                                   e                     e
Supplemental           7.2 percent          $2.8 billion                 Supplemental Security Income is available to individuals who
Security Income        (fiscal year 2001)   (fiscal year 2002)           are blind or disabled and poor. The amount of Supplemental
                                                                         Security Income an individual receives depends on several
                                                                         factors including, but not limited to, other sources of income and
                                                                         living arrangements. To apply for Supplemental Security
                                                                         Income, applicants must visit a Social Security office and meet
                                                                         with a Social Security representative. Examples of
                                                                         documentation required under the program include: (1) social
                                                                         security card; (2) birth certificate or other proof of age;
                                                                         (3) mortgage or lease; (4) payroll slips, bank books, insurance
                                                                         policies, and other records about income and assets; (5) names
                                                                         and addresses of doctors (if disabled); and (6) proof of United
                                                                         States citizenship or noncitizen status. To verify this information,
                                                                         the Social Security Administration uses computer matches to
                                                                         compare Supplemental Security Income records against
                                                                         recipient information contained in records of third parties, such
                                                                         as other federal and state government agencies. The Social
                                                                         Security Administration periodically conducts “redetermination”
                                                                         reviews to verify eligibility factors such as income, resources,
                                                                         and living arrangements. Recipients’ eligibility is to be reviewed
                                                                         at least every 6 years.
Social Security        0.2 percente         $2.0 billione                Social Security Disability Income provides income support
Disability Insurance   (fiscal year 2001)   (fiscal year 2001)           benefits to former workers who have suffered a long-term
                                                                         disability. Applicants can start their application online, but before
                                                                         they are approved for benefits, applicants must provide the
                                                                         following documentation to a social security office: (1) a Social
                                                                         Security number; (2) birth certificate or other proof of age;
                                                                         (3) medical information, such as names and addresses of
                                                                         doctors and medical records; (4) work history for the prior 15
                                                                         years; and (5) a W-2 or tax return.
School Lunch           Not known            $123 millionf                Households submit applications with self-reported information,
                                            (fiscal year 2002)           including the names of household members and all sources of
                                                                         income for each household member, and the Social Security
                                                                         number of the adult that signs the application. Alternatively,
                                                                         children with Temporary Assistance for Needy Families or Food
                                                                         Stamp case number can be certified directly. Generally, no
                                                                         documentation or additional support is requested at the time of
                                                                         application. Local authorities verify eligibility for free and
                                                                         reduced price meals for a sample of applications using either
                                                                         random or focused sampling techniques.




                                               Page 46                                                     GAO-03-794 Earned Income Credit
                                              Appendix II
                                              Overclaim Rates, Administrative Costs, and
                                              Eligibility Verification Processes of Benefit
                                              Programs




(Continued From Previous Page)
Program               Overclaim ratea      Administrative cost          Eligibility verification process
                                   g                    h
Food Stamps           8.66 percent         $2.4 billion                 Food Stamp applicants are asked to provide documentary
                      (fiscal year 2001)   (fiscal year 2002)           evidence of household assets, income, and allowable
                                                                        deductions, as well as proof of noncitizen status. Allowable
                                                                        deductions may include housing and utility expenses, medical
                                                                        expenses, and child support payments. If documentary
                                                                        evidence is not available, state agencies may use other means
                                                                        of verifying information provided by applicants, including
                                                                        contacting third parties. State agencies are required to verify
                                                                        certain information on income and deductions and states may
                                                                        opt to require verification of additional information. State
                                                                        agencies may establish their own standards for the use of
                                                                        verification subject to the parameters specified in federal
                                                                        regulations.
Housing and Urban     10.7 percenti        $945 millionj                Applicants must provide third party verification of the following
Development rental    (fiscal year 2001)   (fiscal year 2001)           factors: (1) family annual income, (2) value of assets, (3)
assistance programs                                                     expenses related to deductions from annual income, and
                                                                        (4) other factors that affect the determination of adjusted
                                                                        income. Housing agencies may require documentation or they
                                                                        may verify self-reported information by telephone. Individual
                                                                        housing agencies determine their own verification procedures.
Medicaid              Not known            11.9 billionk                Medicaid provides health insurance coverage to certain low
                                           (fiscal year 2001)           income adults and children in a program jointly administered
                                                                        and funded by the federal government and the states. While the
                                                                        Social Security Administration sets the income threshold for
                                                                        Supplemental Security Income-related Medicaid eligibility
                                                                        annually, most Medicaid eligibility requirements and verification
                                                                        procedures are determined at the state level and vary by state.
                                                                        For example, some states require applicants to provide
                                                                        documentation of both income and allowable deductions, such
                                                                        as child care expenses and child support payments. Other
                                                                        states require applicants to provide information on income and
                                                                        deductions but do not require further documentation. Federal
                                                                        law requires that Medicaid applicants provide a Social Security
                                                                        number, unless the applicant refuses to obtain a number
                                                                        because of well established religious objections. While states
                                                                        are required to establish procedures for the periodic
                                                                        redetermination of a recipient’s Medicaid eligibility at least
                                                                        annually, the procedures may vary by state.
Medicare              6.3 percentl         4.4 billionm                 The Centers for Medicare and Medicaid Services administers
                      (fiscal year 2002)   (fiscal year 2001)           the Medicare program; however, the Social Security
                                                                        Administration determines entitlement to Medicare benefits.
                                                                        Retired recipients who are receiving retirement benefits from
                                                                        Social Security or the Railroad Retirement Board are
                                                                        automatically enrolled in Medicare the month they turn 65.
                                                                        Individuals who are under age 65 and disabled are also
                                                                        automatically enrolled in Medicare after they have been
                                                                        receiving Social Security or Railroad Retirement disability
                                                                        payments for 24 months. All other individuals (e.g., retired
                                                                        individuals who are not eligible for Social Security and
                                                                        individuals who have end stage renal disease) are required to
                                                                        file a Medicare application at a Social Security office.



                                              Page 47                                                   GAO-03-794 Earned Income Credit
                                                         Appendix II
                                                         Overclaim Rates, Administrative Costs, and
                                                         Eligibility Verification Processes of Benefit
                                                         Programs




(Continued From Previous Page)
Program                           Overclaim ratea     Administrative cost               Eligibility verification process
                                                                     n
Temporary                         Not yet Available   $2.3 billion                      Eligibility requirements are determined at the state or local level,
Assistance for Needy                                                                    and therefore vary by state and locality.
Families
Source: GAO analysis of multiple agency data.
                                                         a
                                                             See table 6 for information on how overclaim rates were calculated for each program.
                                                         b
                                                          IRS does not know the full cost of administering the EIC; for example, the $145 million does not
                                                         include the cost of processing EIC returns.
                                                         c
                                                             United States Department of Labor Benefit Accuracy Measurement data.
                                                         d
                                                             United States Department of Labor.
                                                         e
                                                             Social Security Administration, Performance and Accountability Report, fiscal year 2002.
                                                         f
                                                         United States Department of Agriculture Food and Nutrition Service. Includes state expenses for
                                                         administering the School Breakfast Program, the Child and Adult Care Food Program, and the Special
                                                         Milk Program.
                                                         g
                                                             United States Department of Agriculture Food and Nutrition Service, Quality Control Division.
                                                         h
                                                             United States Department of Agriculture Food and Nutrition Service.
                                                         i
                                                         Housing and Urban Development’s Audit of Financial Statements Fiscal Year 2002 and 2001, 2003-
                                                         Fiscal Year 2004 (January 31, 2001), Note 17, p. 104ff.
                                                         j
                                                         Departments of Veterans Affairs and Housing and Urban Development, and Independent Agencies
                                                         Appropriations for 2003, Hearings. 552-070-28357-9, p.106.
                                                         k
                                                             Health and Human Services’ Financial Management Report, fiscal year 2001.
                                                         l
                                                         Health and Human Services’ Office of Inspector General, Improper Fiscal Year 2002 Medicare Fee-
                                                         For-Service Payments A-17-02-0220, (January 2003).
                                                         m
                                                          The Boards of Trustees, Federal Hospital Insurance and Federal Supplementary Medical Insurance
                                                         Trust Funds, 2003 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and
                                                         Federal Supplementary Medical Insurance Trust Funds. Administrative cost figure includes
                                                         administrative costs for both Federal Hospital Insurance and Federal Supplementary Medical
                                                         Insurance Trust Funds. Administrative costs for Hospital Insurance include the costs of experiments
                                                         and demonstration projects as well as fraud and abuse control expenses.
                                                         n
                                                         Health and Human Services’ Administration for Children and Families, Temporary Assistance for
                                                         Needy Families Program Fifth Annual Report to Congress. (February 2003).


                                                         To the extent known, how the overclaim rates are calculated, for the nine
                                                         benefits program we reviewed, including EIC, is shown in table 5.




                                                         Page 48                                                            GAO-03-794 Earned Income Credit
                                                  Appendix II
                                                  Overclaim Rates, Administrative Costs, and
                                                  Eligibility Verification Processes of Benefit
                                                  Programs




Table 5: How Overclaim Rates Are Calculated for Selected Benefit Programs

Program                                         How overclaim rates are calculated
Earned Income Credit                            Compliance study based on audits of a statistically representative sample of taxpayers and
                                                adjustments made to their tax returns.
Unemployment Insurance                          The quality assurance system is used to estimate overpayments based on a statistically
                                                valid sample of Unemployment Insurance claims from each state. Investigators conduct
                                                detailed, comprehensive analyses of each case by personally contacting employers,
                                                claimants, and third parties. Investigators typically spend 5 to 8 hours examining each case.
Supplemental Security Income                    The payment accuracy rate is based on a detailed analysis of a sample of Supplemental
                                                Security Income cases. However, the Social Security Administration’s Office of Inspector
                                                General reported that not all types of overpayments are counted as errors so payment
                                                accuracy rates do not correspond to overpayments reported in the Social Security
                                                Administration’s financial statements.
Social Security Disability Insurance            The overpayment overclaim rate is based on a monthly sample selection from the payment
                                                rolls consisting of beneficiaries in current payment status. For each sampled case, the
                                                recipient or representative payee is interviewed, collateral contacts are made as needed,
                                                and all factors of eligibility are redeveloped as of the current sample month.
School Lunch                                    The United States Department of Agriculture does not routinely collect data on the
                                                percentage of ineligible children receiving free or reduced price school lunches.
Food Stamps                                     Under the food stamp quality control system, states draw a statistical sample, review case
                                                information, and make home visits to determine whether households were eligible for
                                                benefits and received the correct benefit payment. Regional offices validate the results by
                                                reviewing a subset of each state’s overpayment and underpayment errors as necessary.
Housing and Urban Development rental            The overclaim rate is based on an in-depth analysis of a statistical sample of cases. The
assistance programs                             overclaim rate showed an increase in 2001 over previous years largely because Housing
                                                and Urban Development expanded its methodology for measuring error to cover three types
                                                of program errors – incorrect reporting of income by tenants; mistakes by public housing
                                                agencies, owners, and renting agents in calculating income and rent amounts; and mistakes
                                                made by public housing agencies, owners, and renting agents in completing appropriate
                                                paperwork and billing Housing and Urban Development for rental assistance.
Medicaid                                        GAO has found that few states measure the overall accuracy of their payments.a
Medicare                                        This overclaim rate for Medicare fee-for-service claims is based on a review of claims
                                                conducted by the Housing and Human Service’s Inspector General’s office. The Inspector
                                                General used a multistage stratified sample design. For each claim, the provider was
                                                contacted and asked to provide copies of all medical records supporting services billed.
                                                These records were assessed to determine whether the services billed were reasonable,
                                                adequately documented, medically necessary, and coded in accordance with Medicare
                                                reimbursement rules and regulations. Billing practices were also reviewed. Starting in fiscal
                                                year 2003, the Centers for Medicare and Medicaid Services will publish a national overclaim
                                                rate developed through the Comprehensive Error Rate Testing Program and the Hospital
                                                Payment Monitoring Program. These programs build on the Inspector General’s
                                                methodology.
Temporary Assistance for Needy Families         Payment accuracy overclaim rates have not yet been calculated for the Temporary
                                                Assistance for Needy Families’ program.
Source: GAO analysis of multiple agency data.
                                                  a
                                                   U.S. General Accounting Office State, Efforts to Control Improper Payments Vary, GAO-01-662
                                                  (Washington, DC: June 7, 2001).




                                                  Page 49                                                      GAO-03-794 Earned Income Credit
Appendix III

Objectives, Scope, and Methodology                                                                                  Appendx
                                                                                                                          iI




Objectives     We were asked to respond to 12 questions about IRS’s certification
               program, as shown in table 6.



               Table 6: Questions We Were Asked

               1.    What is the status of the EIC certification program, including the timing and
                     number/types of taxpayers to be contacted?
               2.    Has IRS “tested” or conducted a “focus-group” of any related letters, forms, or
                     documents for understandability and other issues; and, if so, what have been the
                     results of such efforts?
               3.    (a) What is the appropriateness of the draft certification forms and explanations?
                     (b) What are IRS’s plans for processing them? (c) What types of documents will EIC
                     taxpayers need to provide the IRS? (d) Will taxpayers generally be able to obtain the
                     required documentation to otherwise establish eligibility within the required time
                     frame, such as for marriage certificates, school transcripts, and rental agreements?
               4.    What is the range of alternatives considered by IRS for obtaining similarly reliable
                     documentation, including the cost of alternatives, and taking into account the cost of
                     EIC noncompliance?
               5.    What is the percentage of EIC claimants that would be required to precertify prior to
                     the 2004 filing season?
               6.    What information does IRS have regarding differences in the EIC overclaim rate
                     among EIC claimants that are positively correlated with filing status, relationship to
                     the qualifying child, or other factors?
               7.    To what extent are the issues of concern in GAO’s report on the current
                     recertification program of similar concern in the new certification program, including
                     probable solutions to problem areas?
               8.    Does GAO believe the certification program has been adequately developed to
                     prevent unreasonable burdens on EIC taxpayers and to improve compliance?
               9.    What is the current process for evaluating EIC eligibility?
               10. (a) What is the current EIC error rate? (b) Have recent statutory changes had an
                   impact on the error rate or on the rate of overpayments? (c) Were these statutory
                   changes for the purpose of deterring noncompliance?
               11. What are the error rates of non-EIC taxpayer groups having significant compliance
                   issues?
               12. What are the error rates of comparable benefit programs administered by states or
                   the federal government and do these programs use any verification process?
               Source: Subcommittee on Oversight, House Committe on Ways and Means.


               In consultation with our requesters’ offices, we grouped these questions
               into three objectives, as follows: (1) describe the design and basis for the
               EIC qualifying child certification program as proposed by the EIC task
               force, (2) describe the current status of the program, including significant
               changes since program approval, and (3) assess whether the program is



               Page 50                                                                GAO-03-794 Earned Income Credit
              Appendix III
              Objectives, Scope, and Methodology




              adequately developed to (a) prevent unreasonable burdens on EIC
              taxpayers and (b) improve compliance so that the test should proceed. In
              addition, we were asked to provide readily available information on
              (1) significant noncompliance rates other than for the EIC and (2) the
              overclaim rates and administrative costs of comparable benefit programs
              administered by states or the federal government and any verification
              process used by these programs.



Scope and     To respond to all of the questions, we reviewed and analyzed relevant IRS
              and other documentation, such as compliance reports, EIC task force
Methodology   reports, draft letters and forms, testing and focus group records,
              implementation plans, evaluation plans, and our prior products, and
              interviewed Department of the Treasury and IRS officials involved in the
              EIC certification program, including the Assistant to the Commissioner; the
              National Taxpayer Advocate; Research, Analysis, and Statistics officials;
              and members of the qualifying child certification implementation team. We
              did not verify the accuracy of the data shown in the various reports that we
              reviewed. Rather, we reviewed the steps IRS had taken to implement the
              certification program and determined, to the extent possible, how IRS
              ensured that the program had been adequately developed to prevent
              unreasonable burden and improve compliance. We did not evaluate
              whether IRS’s preparations for implementing the certification test, such as
              staffing and training, were sufficiently developed to support proceeding
              with the test, because they were outside the scope of our review, still under
              development, or the Treasury Inspector General for Tax Administration
              had audits planned.

              The first objective includes, in order, our response to questions 10, 4, and 6.
              To determine the current EIC error rates and whether any studies had been
              done on the impact of recent statutory changes on error rates, we reviewed
              IRS’s most recent compliance study, the Treasury Inspector General for Tax
              Administration reports and our previous reports, and interviewed IRS
              officials. In addition, we reviewed the legislative history of recent statutory
              changes—effective since 1999—that pertained to EIC. We analyzed these
              data and IRS and Treasury reports to determine whether an analysis on the
              impact of the legislative changes on EIC error or overclaim rates had been
              conducted. To determine the range of alternatives considered by the task
              force, we reviewed documents and interviewed members of the EIC task
              force. To determine the correlation between overall EIC error rates, filing
              status, and gender, we interviewed officials from Research, Analysis, and




              Page 51                                          GAO-03-794 Earned Income Credit
Appendix III
Objectives, Scope, and Methodology




Statistics and analyzed their data, and reviewed the EIC task force reports
and Treasury’s past compliance studies.

The second objective included, in order, our response to questions one,
five, two, and seven. To determine the status of the EIC certification
program, including the number and types of taxpayers to be contacted, we
interviewed IRS and Treasury officials and reviewed documents showing
timelines and key milestones. We reviewed plans for the certification
program, such as IRS’s Concept of Operations and the 2004 Increment
Evaluation Plan, in conjunction with IRS’s current process for evaluating
EIC eligibility. To calculate the percentage of EIC claimants subject to
certification in 2004, we divided the planned sample size by the number of
EIC claimants with qualifying children. To obtain information on IRS’s
testing of letters, forms, and documents for understandability, we observed
the focus group testing that IRS conducted in Dallas, Tex., with EIC
taxpayers, tax preparers, and other parties to understand how IRS assured
itself that such persons understood the forms and thought they could
obtain the required documentation. For whether items of concern we
found within the recertification program could have similar concerns in the
new initiative, we analyzed our prior reports on IRS’s recertification
program and IRS’s progress in implementing our recommendations, then
we compared our analysis to the certification plans.

The third objective includes, in order, our responses to questions eight and
three. To make our determination as to whether the program had been
adequately developed to improve compliance with minimal burden to
taxpayers, we asked IRS officials to describe and provide documentation to
support the steps they took to assure that the program was adequately
developed. This included interviews and a high-level review of key steps
and decisions found in various documents, such as the EIC task force
reports, the Concept of Operations, staffing plans, training materials, and
the evaluation plan. To determine the potential extent of the burden on
taxpayers, we reviewed reports from outside groups that analyze programs
and policies for low-income groups. We obtained the opinions of IRS
officials and discussed those of outside stakeholders, such as
representatives from the Annie E. Casey Foundation, low income taxpayer
clinics, and large tax preparation organizations, that IRS had met with
about any problems taxpayers might have in complying with the
documentation requirements to establish EIC eligibility. We also
interviewed IRS officials and reviewed EIC task force documents to learn
about the range of alternatives taxpayers have available to obtain similarly




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Appendix III
Objectives, Scope, and Methodology




reliable documentation, if they were unable to comply with the
certification documentation requirements.

Our responses to questions 11 and 12 are in appendixes I and II,
respectively. To determine the error rates of non-EIC taxpayer groups
having significant compliance issues, we reviewed compliance research
reports, interviewed officials about IRS’s National Research Program, and
reviewed information contained in the Strategy and Program Plan. We
discussed our analysis with key IRS officials, including representatives of
the Assistant to the Commissioner. To determine the overclaim rates,
administrative costs, and verification process of comparable benefit
programs administered by states or the federal government, we researched
our prior reports and contacted our staff knowledgeable about the selected
programs. We selected nine programs to review: Unemployment Insurance,
Supplemental Security Income, Social Security Disability Insurance, school
lunch, food stamps, Housing and Urban Development rental assistance,
Medicaid and Medicare, and Temporary Assistance for Needy Families. We
chose these programs largely because they were the same programs the
EIC task force reviewed and because each of them had some sort of
precertification program. We did not do a comprehensive analysis to
determine which programs, if any, were most comparable to the EIC, nor
did we determine whether the information reported for each program was
consistent and could be compared across programs. We did not do
additional analyses to determine how administrative costs compared to
program outlays.

Our response to question nine is in the background section of this report.
To determine the current process for determining EIC eligibility, we
reviewed relevant IRS documents and our prior reports. We verified the
accuracy of this information in interviews with IRS officials.

We conducted our work in Atlanta, Ga., Dallas, Tex., and Washington, D.C.,
from May 2003 through September 2003 in accordance with generally
accepted government auditing standards.




Page 53                                        GAO-03-794 Earned Income Credit
Appendix IV

Key Milestones for the Qualifying Child
Certification Program                                                                                                                                                                       Appendx
                                                                                                                                                                                                  iIV




                                                                 Key milestones for the certification program for fiscal years 2002 through
                                                                 2005, are shown in figure 4.



Figure 4: Key Milestones for the Certification Program


                 February                                  July                                      August
                 ●   EIC task force formed.                ● EIC task force                          ● Qualifying child certification


2002                                                         recommendations approved.                 concept and detailed plans
                                                                                                       developed (through February
                                                                                                       2003).



                 March                                     June                                      July                                            December
                 ●Informal meetings with internal          ● Focus group testing and                 ● A 30-day public                               ●
                                                                                                                                                         Letters notifying taxpayers of
                  and external stakeholders held.            one-on-one interviews held.               comment period ends.                              residency certification
                                                                                                                                                         requirements begin to be mailed.
2003




                 January                                   July                                      September
                 ●
                     Eligibility determinations to be
                                                           ●
                                                               Possible pilot for certification in   ●
                                                                                                         Preliminary evaluation report for
                     made (through October 2004 with           advance of the 2005 filing season         qualifying child certification test to
                     extensions).                              initiated–letters to taxpayers            be completed.
2004                                                           to be mailed.




                 January
                 ●
                     Final evaluation report for
2005                 qualifying child certification test
                     to be completed.


Source: GAO analysis of IRS data.




                                                                 Page 54                                                                          GAO-03-794 Earned Income Credit
Appendix V

Documents Related to the Precertification
Program                                                                                   Append
                                                                                               x
                                                                                               i
                                                                                               V




               According to agency officials, IRS will send each of the 25,000 taxpayers
               subject to precertification four documents, including (1) Notice 84-A, a
               letter informing taxpayers about the new program; (2) Form 8836,
               “Qualifying Children Residency Statement;” (3) Publication 3211M, “Earned
               Income Tax Credit Question and Answers;” and (4) Publication 4134,
               “Free/Nominal Cost Assistance Available for Low Income Taxpayers.”
               Copies of these documents, current as of September 2003, follow.




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Appendix V
Documents Related to the Precertification
Program




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Program




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Program




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Program




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Program




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Program




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Program




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Program




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Program




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Appendix VI

Comments from the Internal Revenue Service                    Appendx
                                                                    iVI




              Page 65           GAO-03-794 Earned Income Credit
Appendix VI
Comments from the Internal Revenue Service




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Appendix VI
Comments from the Internal Revenue Service




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Appendix VI
Comments from the Internal Revenue Service




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Appendix VI
Comments from the Internal Revenue Service




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Appendix VI
Comments from the Internal Revenue Service




Page 70                                      GAO-03-794 Earned Income Credit
Appendix VII

GAO Contacts and Staff Acknowledgments                                                      Append
                                                                                                 x
                                                                                                 iVI




GAO Contacts      Michael Brostek (202) 512-9110
                  Joanna Stamatiades (404) 679-1984




Acknowledgments   In addition to those named above, Tiffany Brown, Evan Gilman, Veronica
                  Mayhand, Kathryn Larin, David Lewis, Donna Miller, Libby Mixon, Cheryl
                  Peterson, and Tom Short made key contributions to this report.




(450216)          Page 71                                     GAO-03-794 Earned Income Credit
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