United States General Accounting Office

GAO Report to the Chairman, Committee on

Ways and Means, House of

Representatives, and to the Honorable

Larry E. Craig, U.S. Senate

July 1998 EARNED INCOME

CREDIT

IRS’ Tax Year 1994

Compliance Study and

Recent Efforts to

Reduce

Noncompliance

GAO/GGD-98-150

GAO United States

General Accounting Office

Washington, D.C. 20548

General Government Division

B-278069 

July 28, 1998

The Honorable Bill Archer

Chairman, Committee on Ways and Means

House of Representatives

The Honorable Larry E. Craig

United States Senate

In April 1997, the Internal Revenue Service (IRS) published the results of its

tax year 1994 Earned Income Credit (EIC) compliance study. The study

showed that of $17.2 billion in EIC claimed during the study period,

taxpayers overclaimed about $4.4 billion, or about 26 percent. In response

to your request, we (1) evaluated IRS’ study methodology to determine if

the reported results were reasonably accurate, (2) identified the primary

sources of EIC noncompliance1

 found in the study, and (3) determined

whether recent IRS compliance efforts are designed to address the primary

sources of noncompliance.

Results in Brief IRS’ estimate of $4.4 billion in EIC overclaims has a 95 percent confidence

interval of $4.0 billion to $4.9 billion. Our evaluation of the study

methodology showed that the estimate is reasonably accurate and

representative of EIC claimants filing between January 15 and April 21,

1995. Some aspects of the study methodology affected the precision of the

results; but, given the scale of the findings, these limitations do not affect

the study’s message or its usefulness in designing compliance approaches.

Although it is a reasonable estimate of EIC overclaims, the entire $4.4

billion should not be viewed as potential savings to the government had IRS

somehow been able to prevent or correct all of these EIC errors. For

returns filed with an EIC claim, the tax year 1994 study was designed to

evaluate taxpayers’ compliance with each EIC eligibility filing requirement,

to produce an overall estimate of EIC amounts claimed in error, and to

identify the sources of these errors. The study was not designed to detect

or quantify EIC claims that taxpayers could have made but did not. For

example, the $4.4 billion overclaim estimate includes about $780 million in

overclaims associated with errors in applying the “adjusted gross income

(AGI) tiebreaker” rule. That rule provides that if a child meets the

conditions to be a qualifying child of more than one person, only the

person who had the highest AGI may treat that child as a qualifying child.

1

“Noncompliance,” as used in this report, includes errors caused by taxpayer mistakes, negligence, or

fraud. Determining whether an EIC claim is fraudulent requires knowing the taxpayer’s intent, which is

difficult to prove.

Page 1 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
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As the 1994 study was designed, if IRS determined under the AGI tiebreaker

rules that a person claiming the EIC was not entitled to it because there

was another person in the household with a higher income, IRS would

disallow the claim and include it as an overclaim in computing the study

results. However, because these overclaims are not offset by any claim

that could have been made by the other person involved in the tiebreaker,

the ultimate savings to the government could be less than $780 million.

The largest source of taxpayer error identified by the tax year 1994 study

relates to EIC requirements that are difficult for IRS to verify—those related

to eligibility of qualifying children. Taxpayer returns with qualifying child

errors accounted for about two-thirds of the $4.4 billion in overclaims.

Failure to meet the child residency test (living with the taxpayer for more

than 6 months, or 1 year if a foster child) was the most common of the

qualifying child errors, followed by errors in applying the AGI tiebreaker

rules.

Unlike income transfer programs such as Temporary Assistance for Needy

Families and Food Stamps, the EIC was designed to be administered

through the tax system.2

 This choice generally should result in lower

administrative costs and higher participation rates and emphasizes that

the credit is for working taxpayers. The trade-off, however, is higher

noncompliance. EIC eligibility, particularly related to qualifying children, is

difficult for IRS to verify through its traditional enforcement procedures,

such as matching return data to third-party information reports. Correctly

applying the residency test and AGI tiebreaker rules, for example, often

involves understanding complex living arrangements and child custody

issues. Organizations that administer programs like Food Stamps are set

up to investigate and verify this type of eligibility before payment is made;

IRS is not. Thoroughly verifying qualifying child eligibility basically requires

IRS to do an audit of the type done in the EIC compliance studies—a costly,

time-consuming, and intrusive proposition. IRS has designed some

compliance efforts to reduce qualifying child noncompliance but cannot

fully address a significant root cause—design of the EIC itself.

With new enforcement tools provided by Congress and an increase in

funding specifically designated for EIC-related activities, IRS began

implementing in fiscal year 1998 a plan that, over a period of 5 years, calls

for attacking EIC noncompliance through expanded customer service and

public outreach, strengthened enforcement, and enhanced research.

2

As a refundable tax credit, EIC amounts in excess of tax liability paid through the income tax system

are transferred to taxpayers through an income tax refund.

Page 2 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
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Together, these activities make up the “EIC compliance initiative.” Many

parts of that initiative are targeted at the primary sources of EIC

noncompliance identified in the tax year 1994 compliance study. Most of

the efforts that make up the EIC compliance initiative had not progressed

far enough at the time we completed our audit for us to make any

judgment about their effectiveness. However, in reviewing IRS’ efforts for

tax year 1997, we identified several implementation issues that could

diminish the initiative’s impact. For example, EIC claimants often file quite

early in the filing season because they receive sizable refunds; however,

IRS offered several of its EIC-related customer service programs during the

1998 filing season after many EIC claimants had already filed their returns.

IRS plans to measure the overall impact of the compliance initiative on the

overclaim rate3

 through annual studies of EIC compliance starting with a

baseline study of tax year 1997 returns. However, the 5-year initiative

could be into its fourth year before IRS has tax year 1997 and 1998 study

data to compare in assessing the initiative’s results. That would be too late

for IRS to identify and implement meaningful adjustments to the initiative.

IRS also plans to measure the results of individual initiative components

implemented in 1998, but some of these results will not be available for

initial planning of fiscal year 1999 activities.

Background The EIC is a refundable tax credit available to low-income, working

taxpayers. Congress created the credit in 1975 to offset the impact of

Social Security taxes on low-income families and encourage low-income

workers to seek employment rather than welfare.

EIC Eligibility The amount of a taxpayer’s credit depends on the number of qualifying

children who meet age, relationship, and residency tests and on the nature

and amount of qualifying income.

Taxpayers with children can claim the EIC if they (1) have at least one EIC

qualifying child,4 (2) meet income tests, (3) file with any filing status

except “married filing separately,” and (4) were not a nonresident alien for

any part of the year. To claim the EIC without a qualifying child, taxpayers

3

The overclaim rate refers to the amount of EIC overclaimed divided by the amount of EIC claimed on

taxpayer returns, corrected for math errors.

4

Complex living arrangements, such as when two unrelated families share a home or when divorced

parents have joint custody of a child, often make it difficult to determine who can claim a child for the

EIC.

Page 3 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

have to meet requirements 2, 3 and 4, be at least 25 but less than 65 at the

end of the year, have lived in the United States for more than half the year,

and must not be claimed as a dependent on another return.

The credit amount gradually increases with increasing income, plateaus at

a maximum amount, and then gradually decreases (in a “phase-out range”)

until it reaches zero when the taxpayer’s earned income or AGI exceeds the

allowable maximum. Taxpayers with AGI falling in the credit’s phase-out

range are to receive the lesser amount resulting from using their earned

income or AGI in calculating the credit.

Recently, Congress made changes to EIC eligibility rules in the Personal

Responsibility and Work Opportunity Reconciliation Act of 1996 (P.L.

104-193) and the Taxpayer Relief Act of 1997 (P.L. 105-34). These changes,

affecting returns filed for tax year 1996 and after,

• denied the EIC to any taxpayer with investment income over a certain

threshold ($2,250 for tax year 1997);5

• defined a “modified AGI” to be used in calculating the credit that excludes

certain losses from investments and businesses;6

• denied the credit to taxpayers without valid Social Security numbers (SSN);7

 and

• excluded certain workfare payments8 from wages for EIC purposes.

5

The investment income exclusion is basically an indirect wealth test intended to eliminate certain

taxpayers from the EIC program. Investment income includes taxable and nontaxable interest, taxable

dividends, net rent and royalty income derived from sources outside the taxpayer’s ordinary course of

trade or business, capital gain net income, and passive activity net income. This provision was

effective beginning in tax year 1996 with a threshold of $2,200. The threshold is to be indexed for

inflation and was increased accordingly to $2,250 for tax year 1997.

6

Effective beginning in tax year 1996, modified AGI for the purposes of the EIC meant AGI determined

without regard to (1) net capital losses, (2) net losses from trusts and estates, (3) net losses from rents

and royalties derived outside the taxpayer’s normal course of trade or business, and (4) 50 percent of

net losses from trades or businesses. The losses subject to the 50-percent exclusion are to be

computed separately with respect to sole proprietorships other than farming, farming sole

proprietorships, and other trades or businesses. Effective for tax year 1998, taxpayers are required to

add to modified AGI (1) tax-exempt interest; and (2) nontaxable distributions from pensions,

annuities, and individual retirement arrangements if not rolled over into similar vehicles during the

applicable rollover period. Also beginning with tax year 1998, the disregarded amount of net losses

from trades or businesses increased from 50 percent to 75 percent with the same computation rules.

7

Taxpayers were already required to provide valid SSNs for qualifying children.

8

Generally, under the Personal Responsibility and Work Opportunity Reconciliation Act of 1996, the

receipt of certain government assistance payments is denied unless the recipient meets certain work

requirements. Wages earned through state-subsidized work experience and community service

programs are referred to as “workfare payments” and are excluded from earned income for the

purposes of the EIC.

Page 4 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
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Table 1 compares the maximum EIC amounts and income limits for tax

years 1994 and 1997.

Table 1: Maximum EIC Amounts and

Income Limits for Tax Years 1994 and

1997

Tax year 1994 Tax year 1997

Number of EIC

qualifying

children

Maximum

EIC amount

Maximum

allowable

income

Maximum

EIC amount

Maximum

allowable

income

None $306 $8,999 $332 $9,769

One 2,038 23,754 2,210 25,759

Two 2,528 25,295 3,656 29,289

Source: IRS EIC tables.

How IRS Detects and

Pursues Noncompliant

Returns

IRS checks individual returns, with and without the EIC, for compliance

while the return is initially being processed and in the months after filing.

Some noncompliance involves mathematical errors and other obvious

mistakes made by taxpayers or their representatives in preparing the

returns. Other noncompliance involves mistakes that can be detected only

through an audit of the return.

The easiest EIC mistakes to identify and correct are those that IRS classifies

as math errors. These errors, identified as the return is processed, include

EIC computation errors and certain qualifying errors (e.g., missing SSNs for

taxpayers and their children).9

 For returns filed on paper, staff in IRS’

service centers are to enter tax return and Schedule EIC data into

computers that check for math errors. If a math error that affects EIC

eligibility or the size of the EIC claim is found, IRS is to reduce or deny the

EIC accordingly. IRS is to then send a notice to the taxpayer explaining the

change to his or her tax liability and refund. Taxpayers have 60 days to

protest IRS’ actions, either in writing or by telephone, and to provide

additional data supporting their original claims. If taxpayers do not

respond to IRS’ notice, they are to get no further correspondence from IRS

about that matter unless they fail to pay any additional tax that was

assessed as a result of IRS’ change.

9

Until the 1997 filing season, SSN errors were not considered math errors and had to be corrected

using the examination procedures discussed at the end of this section. In 1997, as a result of a

provision in the Personal Responsibility and Work Opportunity Reconciliation Act of 1996, IRS began

treating missing or incorrect SSNs as math errors, similar to the way it had historically handled

computational mistakes.

Page 5 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
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Returns that taxpayers attempt to submit electronically are subject to a

series of computerized “filters” that screen the submission for accuracy

and completeness. Submissions with computational mistakes or missing

or invalid data are to be rejected. A taxpayer whose electronic submission

has been rejected can either correct the mistake(s) and resubmit the

electronic return or file the return on paper (with or without the

corrections). If filed on paper, the return would be subjected to the math

error procedures described in the preceding paragraph.

The most serious form of noncompliance involves deliberate attempts to

defraud the government through, for example, phony refund claims. IRS’

primary effort to identify fraudulent refund claims, including those

involving the EIC, is the Questionable Refund Program (QRP), established in

the 1970s and run by IRS’ Criminal Investigation Division. Using a scoring

system based on known noncompliance patterns, an IRS computer

program analyzes all incoming returns to identify those that are potentially

fraudulent. Then, questionable refund detection teams in the 10 service

centers are to perform more in-depth reviews and, if a return is considered

fraudulent, stop any refund before it is issued.

IRS’ examination units in service centers and district offices review other

potentially erroneous EIC claims that do not meet the criteria for inclusion

in the math error or questionable refund programs. Service center staff

review cases that do not require face-to-face contact with the taxpayer.

Cases requiring face-to-face contact are done by district offices.

Questionable refund detection teams are to refer cases with EIC errors that

are not considered fraudulent to the examination units. Examination staff

may also review cases included in special enforcement or compliance

research projects. When examination staff determine that an EIC claim is

erroneous, they are to notify the taxpayer of that finding and advise the

taxpayer of his or her appeal rights. If the taxpayer agrees with IRS’ finding

or disagrees with the finding but fails to overturn it on appeal, the claimed

EIC is to be disallowed or adjusted in accordance with the examiner’s

findings.

IRS’ EIC Compliance

Studies

IRS has undertaken a series of EIC compliance studies in recent years. In

the first study, IRS sampled returns with EIC claims that had been filed

electronically during a 2-week period in January 1994. The results, which

could be generalized only to electronic returns filed during that 2-week

period, showed that 39 percent of the returns involved overstated EIC

claims that represented 26 percent of the dollars claimed. To learn more

Page 6 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
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about EIC compliance, IRS conducted a broader study of tax year 1994

returns filed both electronically and on paper. The results of that study,

released in April 1997, are the subject of this report. In 1996, IRS began a

third study involving tax year 1995 returns. As of June 1998, IRS had not

completed its analysis of the data from that study. All three of these EIC

compliance studies predated the SSN-related math error procedures that

were first implemented in 1997. However, as noted later, IRS adjusted the

findings of its tax year 1994 study to show what the noncompliance rate

would have been if those procedures had been in place then.

As part of a 5 year EIC compliance initiative begun in fiscal year 1998 and

discussed later in this report, IRS plans to measure its progress in reducing

the EIC overclaim rate through annual studies of returns filed with an EIC

claim. According to IRS, the first study of about 2,500 tax year 1997 EIC

returns filed from January through May 1998 is designed to provide a

baseline measure of the validity of EIC claims and types of EIC errors. IRS’

time line for the study shows that it expects to have a final report prepared

by December 31, 1999.10 The results of subsequent studies are to be

compared with that baseline to identify changes in EIC compliance.

Objectives, Scope,

and Methodology

Our objectives were to (1) evaluate IRS’ tax year 1994 EIC compliance study

methodology to determine if the reported results were reasonably

accurate, (2) identify the primary sources of EIC noncompliance found in

that study, and (3) determine whether recent IRS compliance efforts are

designed to address the primary sources of noncompliance.

To evaluate IRS’ study methodology and the accuracy of IRS’ compliance

study results, we reviewed written documentation on the study’s

methodology, reviewed 122 case files,11 interviewed IRS and Treasury

officials involved in the study, reviewed computer programs written by IRS

and Treasury’s Office of Tax Analysis (OTA) that were used to create and

edit the final dataset, and calculated confidence intervals for the data

presented in IRS’ April 1997 report. To assess IRS’ methodology, we

determined whether IRS used generally accepted social science standards,

10In commenting on a draft of this report, IRS officials told us they plan to issue an interim report

earlier in 1999 based on preliminary data they expect to be available by the end of 1998.

11Our objectives in reviewing study case files were to improve our general understanding of how the

study cases were audited, to research case-specific data questions raised during our initial analyses,

and to verify corrections and additions to the data made by Department of the Treasury staff. Given

these objectives, we judgmentally selected 122 cases to review. Because Treasury did extensive

internal consistency testing on the data, we did not verify data entry on a statistical sample of returns;

rather, we verified data entry for key variables on these 122 returns.

Page 7 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

which include the use of (1) unbiased sample selection procedures,

(2) data collection controls, (3) procedures to ensure quality of data used,

and (4) appropriate statistical procedures to generalize the data gathered

and analyzed. In doing so, we considered the following questions:

• Does the study population appear to represent the population of all EIC

filers during the period from January 15 through April 21, 1995?

• Was the sample drawn in accordance with probability selection principles?

• Were sufficient data verifying compliance with all EIC eligibility

requirements collected from the EIC claimant and other sources?

• Were IRS staff collecting the data knowledgeable of how to apply EIC

eligibility rules?

• Did the data collection procedures include controls to help ensure

consistency in the evaluation of cases?

• Was data entry into the final database verified?

• Was the database checked for internal consistency, outliers, and invalid

codes?

• How precise were the reported overclaim estimates?

We also reviewed available data on IRS’ design of the tax year 1997 EIC

compliance study to see how, if at all, that study addressed problems we

identified with the tax year 1994 study.

To determine the primary sources of EIC noncompliance on tax year 1994

returns, we analyzed the tax year 1994 study dataset as provided by IRS and

modified through OTA editing programs. All data are estimates based on the

study sample. Accordingly, we calculated confidence intervals at the

95 percent confidence level to indicate the precision of the estimates.

Unless otherwise noted, the confidence intervals for percentages are

± 5 percentage points or less; for other statistics, the intervals are

± 10 percent or less of the reported value.

To determine whether recent IRS compliance efforts addressed the primary

sources of noncompliance, we

• reviewed IRS documents to identify the scope of EIC-related activities and

related implementation plans;

• interviewed officials responsible for designing and implementing

EIC-related activities at IRS’ National Office, its Brookhaven, Cincinnati, and

Fresno Service Centers, and its Northern California District Office; and

• obtained available data on the results of EIC programs.

Page 8 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

We did our work from September 1997 through May 1998 in accordance

with generally accepted government auditing standards. We requested

comments on a draft of this report from the Commissioner of Internal

Revenue and the Secretary of the Treasury, or their designees. The

Commissioner of Internal Revenue and Treasury Deputy Assistant

Secretary (Tax Analysis) responded in letters dated July 2, 1998, and

June 29, 1998, respectively. Their comments are summarized at the end of

this letter and are reprinted in appendixes I and II. On July 1, 1998, we met

with IRS officials, including the Deputy Chief of Operations, the Acting

Assistant Commissioner for Customer Service, and the Assistant

Commissioner for Research/Statistics of Income, to discuss the

Commissioner’s comments. In addition, IRS and OTA provided technical

comments on our draft. We made changes to the report in response to the

comments where appropriate.

IRS’ Tax Year 1994

EIC Study

Methodology

Followed Generally

Accepted Social

Science Standards

IRS found that of $17.2 billion in EIC claimed during the January 15 to

April 21, 1995, study period, taxpayers overclaimed $4.4 billion, or 25.8

percent of total EIC claimed.12 To determine whether this $4.4 billion

overclaim estimate is reasonably accurate, we evaluated IRS’ study

methodology. Our evaluation was based on the extent to which IRS used

generally accepted social science standards for a research project of this

kind. These standards include use of (1) unbiased sample selection

procedures, (2) data collection controls, (3) procedures to ensure quality

of data used, and (4) appropriate statistical procedures to generalize the

data gathered and analyzed.

Before discussing our analyses, however, it is important to put IRS’ study

findings in perspective. For returns filed with an EIC claim, the tax year

1994 study was designed to evaluate taxpayers’ compliance with each EIC

eligibility filing requirement, to produce an overall estimate of EIC amounts

claimed in error, and to identify the sources of error. The study was not

designed to detect or quantify EIC claims that taxpayers could have made,

but did not. For example, the $4.4 billion overclaim estimate includes

12The study does not reflect IRS procedures initiated in the 1997 filing season that allowed IRS, under

math error authority, to reduce or deny EIC claims on returns filed with missing or invalid SSNs for

qualifying children. According to IRS and OTA analysis, had this SSN math error authority been

available when taxpayers filed their 1994 returns, overclaims would have been reduced by about

$814 million and the overclaim rate would have been about 21 percent. According to OTA, this

estimate does not include overclaims that could have been detected if the taxpayer did not provide a

valid SSN for a child under the age of 1; such errors could not be detected using the tax year 1994

study data because taxpayers were not required to provide SSNs for infants. Also according to OTA,

the estimate does not include overclaims associated with invalid SSNs for primary or secondary

taxpayers, because the data provided by IRS regarding invalid SSNs did not include this information.

Page 9 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
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about $780 million in overclaims associated with errors in applying the AGI

tiebreaker rule. That rule provides that if a child meets the conditions to

be a qualifying child of more than one person, only the person who had the

highest AGI may treat that child as a qualifying child. As the 1994 study was

designed, if IRS determined under the AGI tiebreaker rules that a person

claiming the EIC was not entitled to it because there was another person in

the household with a higher income, IRS would disallow the claim and

include it as an overclaim in computing the study results. However,

because these overclaims are not offset by any claim that could have been

made by the other person involved in the tiebreaker, the ultimate savings

to the government could be less than $780 million.

With this basic limitation in mind, we found that overall, IRS’ study was

designed and conducted in such a way that it produced a reasonably

accurate estimate of noncompliance on returns filed with an EIC claim.

Although some issues with the study design affected the precision of the

results, our analysis showed that these limitations did not affect the

study’s major message or its usefulness in designing compliance

approaches.

IRS’ Study Methodology

Supported the Reported

Findings

IRS’ study is representative of taxpayers filing an EIC claim on a tax year

1994 return filed between January 15 and April 21, 1995.13 We found that

IRS used an appropriate statistical sampling procedure to select the 2,046

returns included in the study,14 and the sample appears to represent

taxpayers who filed an EIC claim during that period. As an indicator of

whether the EIC study sample was representative of EIC returns filed during

13Based on a comparison to IRS data on EIC returns filed for the full year, the sample represents about

80 percent of EIC returns for tax year 1994. The weighted estimate from the tax year 1994 EIC study

showed 15 million EIC returns filed between January 15 and April 21, 1995. The weighted estimate

from IRS’ Statistics of Income (SOI) sample of all returns filed in 1995 showed 19 million EIC returns.

This indicates that about 20 percent of EIC filers for tax year 1994 filed outside the study period. The

study’s estimate of $4.4 billion in overclaims does not include overclaims among those 20 percent. If

the excluded 20 percent are equally as likely to be noncompliant as the taxpayers represented by the

sample, then the overclaim estimate for the entire tax year will be about 20 percent more than

reported. If the excluded filers are more or less compliant, then the impact is unknown. IRS’ study of

tax year 1997 returns extended sampling through May 1998 and should represent an even larger

proportion of the EIC filing population for that year.

14IRS used a two-stage poststratified systematic sample design. In the first stage, IRS selected

.04 percent of electronic and .05 percent of paper EIC returns filed at each service center. The returns

were selected after the math errors had been corrected. In the second stage, the selected returns were

classified into one of four subgroups, or strata. The strata and sampling rates were (1) 100 percent of

male head of household or single filers claiming qualifying children, (2) 25 percent of female head of

household or single filers claiming qualifying children, (3) 10 percent of married taxpayers filing jointly

or as qualified widow(er)s and claiming qualifying children, and (4) 4 percent of filers claiming the EIC

with no qualifying children. The final sample consisted of 2,046 returns—1,250 paper and 796

electronic.

Page 10 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
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the study time frame, we assumed that study returns should have

characteristics similar to EIC returns filed during the entire year, as

measured in IRS’ SOI sample of tax year 1994 returns filed throughout 1995.

IRS’ April 1997 compliance study report compared weighted data on the

distribution of claimants by paper or electronic filing, filing status, number

of qualifying children, AGI range, and source of income for the study

sample and the full tax year 1994 SOI sample. With the exception of the

percentage of EIC claimants reporting self-employment income (6.3 percent

among taxpayers in the compliance study compared to 15.3 percent of

taxpayers in the SOI sample), weighted compliance study data closely

paralleled data based on the SOI sample. The apparent underrepresentation

of claimants reporting self-employment income is discussed in more detail

later.

In evaluating how IRS collected data on the accuracy of taxpayers’ EIC

claims, we considered the following criteria: (1) whether IRS collected

sufficient data to verify each aspect of EIC eligibility, (2) whether field

agents and case reviewers knew how EIC rules were to be applied, and

(3) whether the study procedures included controls designed to ensure

consistency among cases. After reviewing study documentation and

selected case files, we concluded that overall, IRS’ study methodology met

these criteria.

IRS’ data collection proceeded in two stages: initial taxpayer interviews and

supplemental data collection in the field and a final review of complete

case files at the Cincinnati Service Center. For each taxpayer in the study,

IRS built a case file including transcripts of prior years’ returns, the tax year

1994 return, associated information reports (W-2s and 1099s), information

on duplicate use of or invalid qualifying child SSNs, and dates of birth for

filers and their children. Field agents were given initial case files

containing data available at the time, written instructions on the

information required to verify the claim, and checksheets to record

findings. These instructions and checksheets covered all aspects of EIC

eligibility. Field agents were required to contact, in person, the taxpayer;

employers; the transmitter of the electronically filed return, if any; and the

paid preparer, if any. If additional information was needed to verify the

claim, the agents were to contact neighbors, schools, or state agencies as

Page 11 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

appropriate.15 This type of face-to-face contact with the taxpayer was

necessary to verify the claim because eligibility of qualifying children is

self-determined; and, other than SSNs, IRS does not have third-party

information that can be used to verify the children’s eligibility. Data

collection by the field agents was followed by a “best and final” review at

the Cincinnati Service Center. These reviewers had access to additional

information, primarily third-party income reports, that was not available at

the time the field agents contacted the taxpayers. Using this additional

information, the reviewers made final decisions regarding disposition of

the claim.

Most of the taxpayer interviews and other field data collection were done

by IRS special agents from the Criminal Investigation Division or revenue

agents from the Examination Division. The service center reviewers were

Criminal Investigation Division tax examiners. On the basis of our prior

work, we consider these staff generally to be adequately trained in audit

techniques and how to apply EIC rules.

IRS’ study methodology included controls designed to ensure consistency

among cases. IRS used standard data collection checksheets and written

instructions as one means to ensure consistent data collection.16 In

addition, after completing an investigation, the field agents were

instructed to call a study coordinator at IRS’ Cincinnati Service Center to

discuss the case. This study coordinator was to review the findings to

ensure completeness and consistency with other cases before the case

was sent to the Cincinnati Service Center for final review. In spite of these

controls, we found one consistency-related issue, regarding the corrected

filing status for married taxpayers who erroneously filed as head of

household, that may have systematically affected the study findings. This

issue is discussed in more detail later.

In reviewing IRS’ procedures for ensuring the quality of final study data

used, we considered whether IRS (1) verified data entry into the final

database; and (2) checked for internal consistency, outliers, and invalid

15In reviewing case files, we found six instances in which the file did not contain all data relevant to the

taxpayer’s EIC claim. In one case, for example, a taxpayer filed as head of household and claimed a

qualifying child. The Cincinnati Service Center reviewer noted in the case file that the agent did not get

an SSN for the qualifying child’s father, did not find out if anyone else lived in the household, and did

not verify that the qualifying child actually resided there. Within our sample, these appeared to be

isolated instances, however, and not systematic errors.

16Several parallel questions on the field agent and final review checksheets were not always worded

the same way, or with the same choices, which led to some inconsistent coding. For example, the field

agent checksheet item regarding qualifying child errors did not include a choice for “child does not

exist,” and initial coding of these situations was inconsistent. In editing the data, IRS and OTA

searched for and corrected these types of inconsistencies.

Page 12 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

codes. We found that OTA staff did a comprehensive review of the database

to find and correct internal consistency and data transcription errors. This

review of the data was necessary because IRS did not verify data entry or

check for internal consistency within case records as the database was

created.17 We verified data entry of key variables for the 122 cases

included in our case file review and found no data errors. We used the

OTA-corrected data for our analysis.

IRS and OTA used the data to estimate the total amount of EIC overclaimed

by the population represented by the sample of taxpayers filing EIC claims

from January 15 to April 21, 1995. We replicated this analysis and arrived

at the same totals. Data from the study are estimates based on the sample

of EIC returns. To indicate the precision of these estimates, we calculated

confidence intervals at the 95 percent confidence level. For example, as

shown in table 2, IRS determined that taxpayers overclaimed a total of

$4,448 million in EIC. The 95 percent confidence interval for this estimate is

± $412 million (± 9.3 percent of $4,448 million). This indicates that we are

95-percent confident that the actual overclaim amount is between

$4,036 million and $4,860 million. The confidence interval for the

25.8 percent overclaim rate ranges from 23.4 percent to 28.2 percent.

17IRS’ tax year 1997 EIC compliance study documents show that IRS plans to use OTA’s data

verification programs at the time data are entered into the database.

Page 13 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

Table 2: EIC Overclaims on Tax Year 1994 Returns by Number of Qualifying Children Claimed

EIC amount as claimed on taxpayer

returns EIC amount overclaimed

Number of returns and dollar amounts in millions

Number of qualifying children claimed Number of returns Amount Number of returns Amount

One or two

Point estimate

95% confidence interval

Confidence interval as a

 percentage of point estimatea

12.0

11.5 - 12.5

± 4.2%

$16,722

$15,908 - $17,536

± 4.9%

4.2

3.9 - 4.5

± 7.1%

$4,368

$3,959 - $4,777

± 9.4%

None

Point estimate

95% confidence interval

Confidence interval as a

 percentage of point estimatea

3.0

2.3 - 3.7

± 23.3%

$513

$376 - $650

± 26.7%

0.5

0.2 - 0.8

± 60.0%

$81

$24 - $138

± 70.4%

Total

Point estimate

95% confidence interval

Confidence interval as a

 percentage of point estimatea

15.0

14.2 - 15.8

± 5.3%

$17,235

$16,429 - $18,041

± 4.7%

4.7

4.3 - 5.1

± 8.5%

$4,448b

$4,036 - $4,860

± 9.3%

aTo calculate the confidence interval as a ± percentage of the point estimate, we divided the

dollar range of the 95 percent interval by 2 to express it as a ± value, then divided that figure by

the point estimate. For example, the 95 percent confidence interval for EIC amounts claimed by

taxpayers with one or two qualifying children is $15,908 to $17,536 million—a range of

$1,628 million or ± $814 million from the point estimate. The $814 million is 4.9 percent of the

point estimate.

bTotal does not add due to rounding.

Source: GAO analysis of IRS’ tax year 1994 EIC compliance study data.

As shown in table 2, taxpayers with no qualifying children accounted for

only a small portion of the EIC dollars claimed for tax year 1994 and

$81 million of the overclaim total. The 95 percent confidence interval is

$24 million to $138 million.

Besides the overclaim estimate in table 2, IRS included in its report an

estimate of total underclaims by taxpayers filing a tax year 1994 return

with an EIC claim.18 That estimate was $293 million19 and has a confidence

interval of $129 million to $457 million, or ± 56.0 percent of the point

estimate. The sample of taxpayers with underclaimed EIC is too small to

allow IRS to make reliable estimates by number of qualifying children.

18This underclaim estimate applies only to returns filed with an EIC claim. It does not include EIC

claims that taxpayers could have made but did not.

19The $4.4 billion overclaim estimate does not net out these underclaims.

Page 14 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

Minor Methodology

Problems Affected the

Precision of IRS’ Study

Results

Through our review of IRS’ study methodology, we identified two issues

that affected the final study results. These issues are (1) apparent

underrepresentation in the sample of claimants reporting self-employment

income on a Schedule C and (2) apparent inconsistencies in correcting the

filing status of married taxpayers who erroneously filed as head of

household. Although we were not able to precisely quantify their net

impact, our analysis showed that neither of these issues was large enough

in scale to alter the major study findings.

Filers who report self-employment income on a Schedule C appear to be

underrepresented in the tax year 1994 EIC study sample. SOI data for all

taxpayers who filed in 1995 show that 15.3 percent of EIC claimants

reported Schedule C income. In contrast, 6.3 percent of claimants in the

EIC compliance study filed a Schedule C. Self-employment income is often

not subject to third-party information reporting; consequently, IRS has

found that Schedule C filers in general are more likely to misreport their

income than are taxpayers with wage income. A change in income,

however, will often result in an incremental change in the EIC rather than a

full denial. The impact of underrepresenting Schedule C filers in the tax

year 1994 study is unknown and depends on how the filers left out of the

sample might differ from those included. IRS’ ongoing compliance study of

tax year 1997 EIC returns includes specific sampling of Schedule C returns

and will sample through May; that study should be more representative of

Schedule C EIC filers.

Inconsistencies in determining the correct filing status for married

taxpayers who erroneously filed as head of household also may have

affected the final overclaim estimate. Taxpayers who use a filing status of

married filing separately are ineligible for the EIC. Married taxpayers filing

a joint return can claim the EIC if their joint income is within the eligible

income range and they meet other qualifying criteria. When a taxpayer

erroneously claimed head of household and was living with his or her

spouse, the data collection instructions for the tax year 1994 study

specifically directed field agents to use the filing status most advantageous

to the taxpayer, usually married filing jointly (with appropriate changes to

income, dependents, exemptions, etc.).

We, and OTA staff who also reviewed case files, found instances in which

field agents did not follow these instructions. The $4.4 billion overclaim

estimate included $631 million20 accounted for by taxpayers whose filing

status was changed by IRS to married filing separately in the absence of

20Confidence interval is ± 29 percent of the point estimate.

Page 15 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

qualifying child errors and whose EIC was denied completely. It appears

that some of these taxpayers may have been eligible for the EIC had IRS

prepared a joint return; and, to the extent that their joint income would

have allowed an EIC claim, the $631 million may be overstated.21 Although

this filing status issue reduces the precision of the study findings,

particularly in terms of identifying sources of noncompliance, we believe

its impact to be relatively minor given the size of the total overclaim

estimate. IRS data collection instructions for the tax year 1997 study state

that field agents should attempt to obtain a copy of the spouse’s 1997

return to insert into the case file when filing status is changed to married

filing jointly or married filing separately. However, the instructions did not

specifically state that married filing jointly should be the presumptive

filing status.

Largest Source of EIC

Overclaims for Tax

Year 1994 Was

Nonqualifying

Children

The largest source of noncompliance found in the tax year 1994 study

relates to the EIC requirements most difficult for IRS to verify—those

related to the eligibility of qualifying children. As shown in figure 1,

taxpayer returns with qualifying child errors accounted for at least 65

percent of the $4.4 billion in overclaims—56 percent from returns with

qualifying child errors only and an additional 9 percent from returns with

qualifying child errors made in conjunction with a filing status change to

married filing separately.22 Claiming a child who did not meet residency

requirements was the most common qualifying child error, and errors

claiming head of household status often occurred with claims for

nonqualifying children. Misreported income accounted for another

16 percent of the overclaim total; taxpayers whose filing status was

changed to married filing separately, in the absence of qualifying child

errors, accounted for most of the remainder.

21We do know that of the 423,000 returns (confidence interval ± 20.6 percent of the estimate) that IRS

changed from head of household to married filing jointly, 58 percent (confidence interval

± 11 percentage points) still qualified for some amount of EIC.

22The “other error” category in figure 1 includes some returns with both qualifying child and income

errors.

Page 16 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

Figure 1: Sources of EIC Overclaim

Errors, Tax Year 1994

56%

16%

14%

9%

Qualifying child errors

only

Qualifying child error and

filing status change to

married filing separately

Misreported income

only

Filing status change to

married filing separately

and no qualifying child

error

5% Other errors

Qualifying child errors accounted for at least 

65% of the $4.4 billion in overclaims.a

aThe “other error” category includes some returns with both qualifying child and income errors.

Source: GAO analysis of IRS’ tax year 1994 EIC compliance study data.

Failure to Meet Residency

Requirements Was the

Predominant Qualifying

Child Error

In order for a taxpayer to claim a qualifying child,23 the following rules

applied for tax year 1994.

1. Relationship: The child must have been the taxpayer’s son, daughter,

adopted child, grandchild, stepchild, or eligible foster child. A foster child

is defined as any child cared for as the taxpayer’s own.24

23The definition of a qualifying child for the EIC differs from the definition of a dependent used to

claim a tax exemption. One major difference is that to claim a dependent, the taxpayer generally must

have provided over half the child’s support during the calendar year. In contrast, EIC qualifying child

eligibility depends on residency and does not include a financial support test.

24If the child was married at the end of the year, that child is generally a qualifying child only if the

taxpayer can claim the child as a dependent.

Page 17 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

2. Age: The child must have been under age 19, or under age 24 and a

full-time student, or any age and permanently and totally disabled.

3. Residence: The child must have lived in the United States with the

taxpayer for more than half of the year or the entire year for foster

children.25

4. AGI tiebreaker: If a child meets the conditions to be a qualifying child of

more than one person, only the person who had the highest AGI may treat

that child as a qualifying child. This rule does not apply if the other person

is the taxpayer’s spouse and they are filing a joint return. For example, if a

child meets conditions to be a qualifying child for both a parent and

grandparent who share a household and the grandparent has a higher AGI,

the grandparent must claim the child. If the grandparent’s AGI exceeds the

maximum income threshold, neither the parent nor the grandparent may

claim the EIC for that child.

As shown in table 3, qualifying child errors were involved in overclaims

totaling $3.1 billion. About $1.7 billion26 of that amount involved qualifying

children who did not meet the residency test, either alone or in

combination with a failure to meet the relationship test. Failure to apply

the AGI tiebreaker rules added an additional $782 million in overclaims.

Together, these two types of qualifying child errors accounted for about

half of the $4.4 billion overclaim total. As noted earlier, however, IRS’ study

did not offset overclaims by claims that could have been made by other

taxpayers. For example, in AGI tiebreaker cases, it is possible that the

taxpayer with the higher AGI might have been able to claim an EIC. It is also

possible in residency cases that a taxpayer in the household where the

child actually lives could make an EIC claim for the child in question. The

extent to which AGI tiebreaker and residency cases involved an EIC claim

that could have been made by another taxpayer, but was not, is unknown.

25A child is considered to have lived with the taxpayer for the full year if the child was born or died

during the year and the child lived with the taxpayer for the entire time the child was alive during the

year. Beginning in tax year 1995, the EIC was extended to taxpayers living outside the United States

because of a military assignment if they meet all other criteria.

26Confidence interval is ± 12 percent of the point estimate.

Page 18 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
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Table 3: EIC Overclaims Involving a Qualifying Child Error, by Qualifying Child Test Failed, Tax Year 1994

Point estimates for overclaims with a qualifying

child error Confidence interval at the 95% confidence levela

Number of returns in thousands, dollars in millions

Qualifying child test failed Returns Amount Returns Amount

Residency only 1,102 $1,470 937 - 1,267 $1,238 - $1,702

AGI tiebreaker only 578 782 450 - 706 585 - 979

Relationship only 228 324 155 - 301 207 - 441

Residency and relationship 132 181 80 - 184 98 - 264

Otherb 257 324 169 - 345 204 - 444

Total 2,297 $3,080c 2,067 - 2,527 $2,740 - $3,420

Note: The table includes data for all qualifying child errors, including those made in conjunction

with income or filing status errors.

aConfidence intervals for overclaim return and amount totals, expressed as percentages, are ±

10 percent and ± 11 percent of the point estimates, respectively. Others range from ± 15 percent

to ± 46 percent.

bThe “other” category includes qualifying child age errors, unspecified child errors, qualifying

children found not to exist, and combinations of errors other than relationship and residency.

cColumn does not add to total due to rounding.

Source: GAO analysis of IRS’ tax year 1994 EIC compliance study data.

Erroneous Filings as Head

of Household Often

Occurred With an EIC

Overclaim

Filing status per se does not affect either EIC eligibility or credit amounts,

except for married taxpayers filing separate returns who are ineligible for

the EIC. As shown in table 4, however, head of household errors occurred

on returns accounting for $3.4 billion in overclaims, or about

three-quarters of the $4.4 billion in overclaims on all returns. For

taxpayers whose filing status was changed to single, qualifying child errors

accounted for most of the overclaims. For taxpayers whose filing status

was changed to married filing jointly, most of the overclaims were

attributed to income errors. Among taxpayers whose EIC was denied

because their filing status was changed to married filing separately, about

40 percent of the overclaim amounts were also associated with qualifying

child errors.

Page 19 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

Table 4: EIC Amounts Overclaimed by

Taxpayers Erroneously Filing as Head

of Household, by Corrected Filing

Status, Tax Year 1994

Dollars in millions

Head of household filing

status changed to:

Point estimates for

amount of EIC overclaimed

Confidence interval at the

95% confidence levela

Single $1,964 $1,712 - $2,216

Married filing jointly 390 277 - 503

Married filing separately 1,008 792 - 1,224

Total $3,362 $3,029 - $3,695

aConfidence intervals expressed as percentages range from ± 10 percent to ± 29 percent of point

estimates.

Source: GAO analysis of IRS’ tax year 1994 EIC compliance study data.

Among all taxpayers who filed as head of household for tax year 1994,

regardless of final filing status, male taxpayers had an overclaim rate

nearly twice that of female taxpayers.27 Of $3.2 billion in EIC claims by

male head of household filers, $1.7 billion, or about 51 percent,28 was

overclaimed. In contrast, female head of household filers overclaimed

$2.0 billion,29 or about 25 percent,30 of $8.2 billion in EIC they claimed.

Misreported Income

Accounted for a Relatively

Small Portion of EIC

Overclaims

Errors in reporting income, with no other eligibility errors, accounted for

$708 million31 in EIC overclaims, or 16 percent of total overclaims. Included

in this group are taxpayers who (1) used the correct filing status but

misreported their income or (2) were married and erroneously filed as

head of household or single and whose filing status was changed to

married filing jointly. The filing status error, per se, had no impact on the

EIC; however, when IRS changed the filing status to married filing jointly

and modified the taxpayers’ returns to include the correct combined

income for both parties, the EIC was often reduced or denied completely.

27As the sample returns were selected, IRS used taxpayers’ names to determine gender. For those

cases in which the taxpayer’s gender was not obvious, IRS referred to SOI files, which include gender

data. Gender information was confirmed during the taxpayer interview.

28Percentage calculated using the actual estimates rather than the rounded numbers presented in this

sentence.

29Confidence interval is ± 16 percent of the point estimate.

30Percentage calculated using the actual estimates rather than the rounded numbers presented in this

sentence.

31Confidence interval is ± 27 percent of the point estimate.

Page 20 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

These adjustments accounted for about $309 million32 of the

income-related overclaims.

Returns Done by Informal

Preparers Had a Higher

Overclaim Rate

In general, about half of EIC claimants use a return preparer rather than

completing the return themselves. Using codes developed by OTA,

33 we

grouped prepared returns into the following three categories: those

prepared by (1) “formal preparers,” which includes attorneys, Certified

Public Accountants, national tax preparation companies, and enrolled

agents;34 (2) “IRS preparers,” which includes staff at IRS walk-in sites and at

IRS-supported volunteer organizations like Volunteer Income Tax

Assistance and Tax Counseling for the Elderly; and (3) “local or informal

preparers,” which includes anyone not in the other two categories.

The study data show that there was little difference in EIC noncompliance

between self-prepared returns and those done by preparers. Both groups

had overclaim rates of about 26 percent. A more detailed analysis,

however, shows that overclaim rates varied by type of preparer. As shown

in figure 2, the rate on returns prepared by local or informal preparers was

31 percent; the overclaim rate on returns prepared by formal preparers

was 20 percent. The sample included too few IRS-prepared returns to allow

us to make a reliable overclaim estimate for that group.

32Confidence interval is ± 34 percent of the point estimate.

33According to OTA, it used two approaches to classify a return as being done by a preparer. Under the

first approach, a return was classified as being done by a preparer only if a preparer was indicated on

the filer’s return. Under the second approach, a return was classified as being done by a preparer if a

preparer was indicated on the filer’s return or if IRS investigators found evidence that a preparer was

used. There was little difference in the analysis results between the two groups; for our analysis, we

used the second approach.

34An enrolled agent is a preparer who has demonstrated special competence in tax matters on a

written examination administered by IRS.

Page 21 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

Figure 2: EIC Overclaim Rates for

Returns Done by Paid Preparers, by

Type of Preparer, Tax Year 1994

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

32

34

36

Local or informal

preparers

Formal

preparers

Percentage of EIC overclaimed

Overclaim rate (26%) for all returns prepared with

assistance and for self-prepared returns

31

20

Note: Formal preparers include attorneys, Certified Public Accountants, enrolled agents, and

national tax preparation firms.

Source: GAO analysis of IRS’ tax year 1994 EIC compliance study data.

Tax Year 1994 Study

Provided Limited Data on

Taxpayer Intent

Knowing the extent to which EIC overclaims are due to honest mistakes

versus intentional misstatements is important in targeting compliance

approaches. If, for example, errors are due to a misunderstanding of EIC

rules, taxpayer education and assistance efforts would be warranted.

Taxpayers intentionally misclaiming the EIC require different approaches.

As part of the tax year 1994 study, IRS made a determination of taxpayer

intent. Both field agents and Cincinnati Service Center case reviewers

were to classify taxpayers’ errors as intentional (e.g., the taxpayer knew

that a child did not meet EIC qualifying child tests); or unintentional (e.g.,

the taxpayer did not understand the eligibility rules or EIC instructions).

We found that field agents had not made determinations of intent in about

40 percent of the final overclaim cases. In almost all of these instances,

however, Cincinnati reviewers made a determination of intent as part of

Page 22 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

their best and final review. Based on best and final case data, about

one-half of the 4.7 million returns with an EIC overclaim and two-thirds of

the total amount overclaimed were considered to be the result of

intentional errors. These assessments are judgmental in nature and should

not be considered precise measures of intentional and unintentional

taxpayer errors. However, the results do indicate that IRS’ compliance

efforts should include activities aimed at taxpayers who intentionally

misclaim the EIC.

Examiners working tax year 1997 compliance study cases are to collect

data related to taxpayer intent. The data collection checksheet for that

study includes a question asking examiners to decide if errors were due to

complexity of the tax form, difficulty understanding the law, a

computational error, a potential fraud scheme, or some other reason. This

provides more specific choices, particularly for unintentional error, but

the determinations of intent will still be judgmental.

Recent Compliance

Efforts Are Aimed at

Major Sources of

Noncompliance, but It

Is Too Early to

Measure Their Effect

With new enforcement tools provided by Congress and an increase in

funding specifically designated for EIC-related activities, IRS began

implementing in fiscal year 1998 a plan that calls for attacking EIC

noncompliance through expanded customer service and public outreach,

strengthened enforcement, and enhanced research. Together, these

activities constitute what we refer to as the “EIC compliance initiative.”

Many parts of that initiative are targeted at the major sources of EIC

noncompliance discussed in the prior section. However, in reviewing IRS’

efforts for tax year 1997, we identified several implementation issues that

could diminish the initiative’s impact.

As we have previously testified before Congress,35 IRS’ ability to reduce EIC

noncompliance is limited by the design of the credit. Unlike income

transfer programs such as Temporary Assistance for Needy Families and

Food Stamps, the EIC is designed to be administered through the tax

system rather than through other state or federal agencies. This choice

generally should result in lower administrative costs and higher

participation rates and emphasizes that the credit is for working

taxpayers. The trade-off, however, is higher noncompliance. EIC eligibility,

particularly related to qualifying children, is difficult for IRS to verify

through traditional enforcement procedures, such as matching return data

to third-party information reports. Correctly applying the residency test

35Earned Income Credit: Noncompliance and Potential Eligibility Revisions (GAO/T-GGD-95-179, June

8, 1995); and Tax Administration: Earned Income Credit Noncompliance (GAO/T-GGD-97-105, May 8,

1997).

Page 23 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

and AGI tiebreaker rules, for example, often involves understanding

complex living arrangements and child custody issues. Organizations that

administer programs like Food Stamps are set up to investigate and verify

this type of eligibility before payment is made; IRS is not. Thoroughly

verifying qualifying child eligibility basically requires IRS to do an audit of

the type done in the EIC compliance studies—a costly, time-consuming,

and intrusive proposition. IRS has designed some compliance efforts to

reduce qualifying child noncompliance but cannot fully address a

significant root cause—design of the EIC itself.

Most of the efforts that make up the EIC compliance initiative had not

progressed far enough at the time we completed our audit for us to make

any judgment about their effectiveness. IRS plans to measure the overall

impact of its compliance initiative on the EIC overclaim rate through

annual studies of EIC compliance starting with a baseline study of tax year

1997 returns. However, the 5-year initiative could be into its fourth year

before IRS has tax year 1997 and 1998 study data to compare in assessing

the initiative’s results. That would be too late for IRS to identify and

implement meaningful adjustments to the initiative. IRS plans to measure

the results of individual programs implemented in 1998, but some of these

results will not be available for planning fiscal year 1999 activities.

Recent Legislation Was

Aimed at Reducing EIC

Noncompliance

Upon release of IRS’ April 1997 report on the results of its tax year 1994 EIC

compliance study, the Department of the Treasury announced six

legislative proposals directed at reducing EIC noncompliance. Congress

included four of the six proposals in the Taxpayer Relief Act of 1997

(TRA97). Specifically, these provisions (1) require paid preparers to fulfill

certain due diligence standards when preparing EIC claims for taxpayers;

(2) provide that taxpayers who fraudulently claim the EIC can be denied

the credit for 10 years, and those who recklessly or intentionally disregard

the rules and regulations can be denied the credit for 2 years; (3) provide

that taxpayers who are denied the EIC through IRS’ deficiency procedures36

are ineligible to claim the EIC in subsequent years unless they provide

evidence of their eligibility through a recertification process; and (4) allow

IRS to levy up to 15 percent of unemployment and means-tested public

assistance and certain other specified payments. In addition, TRA97

included provisions that (1) give IRS access to the Department of Health

and Human Service’s (HHS) Federal Case Registry of Child Support Orders,

a federal database compiling state information on child support payments

36As defined by IRS, deficiency procedures include administrative procedures, other than procedures

related to math or clerical errors, that result in an assessment of a deficiency in tax.

Page 24 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

that could help IRS identify erroneous EIC claims by noncustodial parents;

and (2) require the Social Security Administration (SSA) to collect SSNs of

birth parents and provide IRS with information linking the parents’ and

child’s SSNs.

Besides the new enforcement tools provided in TRA97, Congress began

funding the EIC compliance initiative. For fiscal year 1998, the first year of

what is to be a 5-year effort, Congress appropriated $138 million. For the

second year (fiscal year 1999), IRS has requested $143 million. Funding

over the full 5 years is expected to total $716 million. IRS is using the

compliance initiative funds to expand existing EIC-related activities and to

initiate several new efforts, including implementation of the TRA97

provisions.

IRS’ Efforts Are Targeted

at Major Sources of EIC

Errors

The various activities being funded as part of the EIC compliance initiative

in fiscal year 1998 fall into three broad categories: (1) customer service

and public outreach, (2) enforcement, and (3) compliance research.

Primary efforts in each of those categories are listed in table 5.

Page 25 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
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Table 5: IRS’ EIC Compliance Actions in Fiscal Year 1998

 EIC-related compliance activities for fiscal year 1998

Customer service and public outreach

•Expanded telephone access for EIC-related issues to 7 days a week, 24 hours a day

•Provided Saturday assistance at more than 150 walk-in sites from March 7 to April 11, 1998

•Promoted March 28 as EIC Awareness Day and April 4 and 11 as Problem Prevention days

•Took various steps to alert taxpayers and practitioners about changes relating to the EIC

Enforcement

•Issued notice 97-65 notifying practitioners of new due diligence requirements and allocated 18 staff years to do face-to-face

compliance reviews of return preparers

•Increased QRP staffing to screen 1.3 million more questionable returns

•Increased staffing in correspondence examination program to handle a total of 50,000 EIC case referrals, primarily from the QRP

•Increased Criminal Investigation staffing by 40 special agents and 10 aides to investigate potential fraud cases, including those

involving return preparers

•Issued notices informing more than 383,000 EIC taxpayers that IRS had identified an SSN problem on their tax year 1996 returns

and reminding them to correct the problem before filing their tax year 1997 returns

•Expanded the EIC math error program to include invalid SSNs for primary taxpayersa

•Increased staffing to process a total of 25,000 cases involving taxpayers who, after receiving a math error notice denying their EIC

claim, protest IRS’ action but provide no documentation to substantiate their protests

•Selected 140,000 returns for audit because of duplicate use of SSNs for EIC qualifying children

•Increased staffing to audit about 300,000 tax returns with potential errors claiming head of household filing status and qualifying

children

Compliance research

•Baseline compliance study of tax year 1997 EIC returns

•EIC claimant profile study and longitudinal study of EIC claimant filing patterns

•Feasibility analysis for using two federal databases as authorized under TRA97: the SSA database linking parent and child SSNs

and the HHS Federal Case Registry of Child Support Orders

•Study of noncompliance among EIC claimants who report income from self-employment

aThe “primary” taxpayer is the taxpayer filing the return or, on a joint return, the taxpayer listed

first.

Source: IRS EIC compliance initiative documents.

As indicated in table 5 and discussed in more detail below, several

components of the EIC compliance initiative are directed at issues that

were identified by the tax year 1994 EIC compliance study as major sources

of EIC errors.

Customer Service and Outreach To the extent that EIC errors, whether they involve qualifying children

requirements, filing status, or misreported income, are unintentional and

Page 26 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

due to a misunderstanding of the rules, IRS’ customer service and outreach

efforts may help improve compliance. IRS data show that many taxpayers

took advantage of the expanded customer service IRS offered in 1998. For

example, IRS expanded telephone access for EIC-related issues to 7 days a

week, 24 hours a day. According to IRS data, 95,000 taxpayers called the EIC

assistance lines during the times when IRS’ other assistance lines were not

available. In addition, IRS provided Saturday walk-in assistance at between

152 and 173 sites from March 7 through April 11, 1998. IRS data show that

staff available on these 6 Saturdays helped 2,949 taxpayers prepare their

EIC returns and provided 1,032 others with different types of EIC-related

assistance. According to IRS, this is in addition to 185,305 EIC taxpayers

assisted on weekdays during the filing season.

Some choices IRS made in implementing its assistance and outreach efforts

in 1998, however, limited the number of persons who might have

benefited. For example:

• IRS did not offer Saturday walk-in assistance until March 7, by which time

millions of EIC claims had already been filed. IRS reported that it had

received about 7.4 million EIC claims as of February 21, 1998—2 weeks

before the first Saturday that walk-in help was available. EIC Awareness

and Problem Prevention days were held even later in the filing season. IRS

said that it did not offer Saturday service earlier in the year because “prior

to receiving the [EIC] appropriation, we had anticipated having Saturday

service for only the last six weeks of the filing season” when, according to

IRS officials, demand among all filers is generally higher. The date for the

EIC Awareness Day was selected so that IRS would have adequate time to

publicize and provide for quality service to the public. IRS officials said, in

retrospect, it could have been more effective if scheduled earlier.

• IRS did not advertise the 24-hour availability of telephone assistance for

EIC-related issues. IRS informed taxpayers of this service only if they

received a notice from IRS about a problem with the EIC claims on their tax

returns. IRS officials told us that they did not advertise this service because

they thought that it would lead to many non-EIC calls during the hours

when other assistance lines were closed.37

As noted earlier, TRA97 included provisions that allow IRS to deny future EIC

claims. These provisions are to be implemented in 1999, based on returns

filed in 1998. For example, persons found to have intentionally disregarded

the rules and regulations in filing their EIC claims in 1998 can be denied the

37This should not be a problem in 1999 when IRS plans to offer 24-hour assistance on all of its

telephone assistance lines. In commenting on a draft of this report, IRS said that this expanded service

will be advertised in all tax packages and elsewhere.

Page 27 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

credit for the following 2 years. IRS attempted to warn taxpayers about the

implication of these provisions before they filed their returns in 1998.

Those outreach efforts were intended to create a deterrent effect by

providing an incentive for intentionally noncompliant taxpayers to file a

correct return and for other taxpayers to be sure that they understand the

EIC rules before filing. To the extent that result was achieved, the number

of EIC errors may have been reduced. Although we have no way of

knowing how successful those warnings were in encouraging better

compliance, we believe that the chances for success might have been

enhanced if IRS had done a better job of publicizing those warnings.

In that regard, IRS’ income tax return instructions did not alert taxpayers as

clearly as they could have about the TRA97 provisions and their

implications. The tax year 1997 Form 1040 tax package included the

following statement in its general information on “what’s new for 1997”:

“Caution: If it is determined that you are not entitled to the EIC you claim,

you may not be allowed to take the credit for certain future years. See

[Publication] 596 for details.” A reference to this caution was not

included later in the package either with the instructions for filling in the

EIC line item on the tax return, the EIC worksheets, or the Schedule EIC that

taxpayers must submit with their returns to substantiate their EIC claims.

Thus, IRS was relying on taxpayers to read the general information in the

front of the tax package before preparing their returns and, assuming they

did, to order Publication 596 for details. For tax year 1996, about

19 million taxpayers claimed the EIC and IRS distributed about 636,000

copies of Publication 596. We believe that potential EIC claimants would

have been more likely to read the relevant information from Publication

596 if it had been included in the Form 1040 instructions, along with

statements in the EIC-specific parts of those instructions that clearly

alerted taxpayers to the existence of that warning and where to find it.38

38The tax year 1997 version of Publication 596, entitled Earned Income Credit, included the following

two paragraphs:

“Beginning in 1997, if you improperly claim the [EIC] due to reckless or intentional disregard of IRS

rules or regulations, you cannot claim the credit for the next 2 years. Also, if you fraudulently claim the

[EIC] you cannot claim the credit for the next 10 years. These sanctions are in addition to any other

penalty imposed, such as the accuracy-related penalty or the fraud penalty.

“Beginning in 1997, if you improperly claim the [EIC] and IRS denies it as a result of deficiency

procedures, you cannot claim the credit again unless you provide information required by the IRS that

shows you are eligible to claim the credit. The IRS will send you information about how to become

recertified. If you claim the credit without first being recertified by the IRS, your claim will

automatically be denied. The recertification procedures can apply if you are subject to the above

described 2- or 10-year disallowance period.”

Page 28 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

Enforcement and Research The customer service and outreach efforts discussed above are generally

broad based and not targeted to specific sources of EIC noncompliance. In

contrast, IRS’ compliance initiative includes several enforcement and

research activities that are specifically targeted on issues relating to

qualifying children, the head of household filing status, noncompliant

return preparers, and misreported income.

Qualifying child errors. IRS’ tax year 1994 EIC compliance study showed

that qualifying child errors associated with the residency requirement and

AGI tiebreaker rules accounted for about half of the $4.4 billion EIC

overclaim total and 1.8 million39 of the 2.3 million returns with a qualifying

child error. These errors undoubtedly included both unintentional

mistakes and intentional noncompliance and involved a variety of complex

living situations.

IRS is able to verify some EIC eligibility criteria using tax return or Schedule

EIC information and does so through its math error program as returns are

submitted. IRS receives few indicators, however, of other problematic

eligibility requirements, such as qualifying child residency or the presence

of another taxpayer in the household who should be claiming the child. IRS

has targeted its enforcement efforts on those compliance problems that

can be identified from tax return information or profiles of noncompliant

returns and is able to resolve some eligibility issues through

correspondence audits. However, the bulk of noncompliance, primarily

related to qualifying children, can best be identified through face-to-face

audits.

One component of the compliance initiative that combines elements of

customer outreach and enforcement is targeted on cases where a

qualifying child’s SSN is used on more than one tax return for the same tax

year. Because a qualifying child can be claimed only once, resolution of

these duplicate SSN cases should eliminate EIC claims by taxpayers with

whom the child did not reside. For the outreach portion of this effort, IRS

identified about 225,000 qualifying child SSNs that had been used by more

than one taxpayer on tax year 1996 returns. In December 1997, IRS sent

taxpayers using these SSNs (about 383,000 taxpayers) a notice informing

them of the problem and reminding them to file a correct return for tax

year 1997. To evaluate the effectiveness of these notices, IRS plans to check

for duplicate use of these qualifying child SSNs on tax year 1997 returns.

According to IRS, it plans to begin its evaluation in September 1998 and

report the results in February 1999.

39Confidence interval is ± 11 percent of the point estimate.

Page 29 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

For the compliance portion of this effort, IRS allocated additional staff to

audit as many as 140,000 taxpayers who had used about 92,000 duplicate

qualifying child SSNs in both tax years 1995 and 1996.40 According to IRS

officials, as of May 16, 1998, about 103,000 of the 140,000 taxpayers had

filed tax year 1997 returns, and IRS had frozen their refunds. Also as of

May 16, 1998, however, IRS had released 49,000 of the refunds for taxpayers

who had corresponded with IRS but whose conflicting claims for the

child(ren) in question were not resolved.41 In discussing the release of

these refunds, IRS officials told us that it could not process the amount of

correspondence received because IRS (1) did not have enough time to

adequately prepare for the start of this project (e.g., get staff assigned,

procedures developed, and training done); and (2) had underestimated the

volume of taxpayer contacts it would receive. Although IRS is continuing to

investigate these cases, its effectiveness in protecting the revenue has

been compromised because it is more difficult (and more costly) to recoup

an erroneous refund once it has been released. IRS officials told us that

meaningful data on the results of this effort would not be available until

September 1998.

Another way that IRS attempts to deal with qualifying child errors is to

deny EIC claims when the taxpayer has failed to provide valid SSNs for the

listed children.42 This effort, which is part of IRS’ math error program,

began before the compliance initiative and has continued as part of the

initiative. As of June 4, 1998, IRS had sent about 535,000 EIC SSN-related

math error notices to tax year 1997 filers; at the same point in 1997, IRS had

sent about 774,000 such notices to tax year 1996 filers. IRS data for all of

tax year 1996 show that it stopped approximately $876 million in

erroneous refunds through the EIC SSN math error program. As of

March 1998, IRS data show that it stopped about $414 million in tax year

1997 refunds.43 IRS expected to issue fewer SSN math error notices in 1998

because IRS, before the 1998 filing season, had sent notices to about

600,000 taxpayers with known SSN problems telling them what to do to

correct the situation before filing their tax year 1997 returns.

40The 140,000 taxpayers selected for audit as part of this project were not included in the group of

383,000 taxpayers who received notices related to duplicate SSN use.

41Also as of May 16, 1998, IRS had released refunds for 21,000 taxpayers who did not claim the

disputed child for 1997 and another 4,500 taxpayers who, on the basis of audits of 1996 returns, were

entitled to claim the disputed child(ren).

42A valid SSN is one in which the SSN and associated name match the information in SSA’s files.

43If taxpayers, after receiving the math error notice, correct the SSN problems that caused their

refunds to be stopped, IRS is to release the refunds. Because that process can take several months, the

$414 million in stopped refunds as of March 1998 is likely to decrease as the year progresses.

Page 30 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

TRA97 included provisions giving IRS access to an SSA data file linking parent

and child SSNs and a Federal Case Registry of Child Support Orders to be

administered by HHS. The Federal Case Registry is to be a compilation of

state child support and custody data. Access to both data files is intended

to augment IRS’ ability to detect EIC claims for nonqualifying children. Both,

however, are still in development, and IRS plans to do a “feasibility

analysis” regarding their use. However, it will be several years before IRS

will be able to use these data. Access, in terms of the specific data fields

IRS can obtain, is still a major issue to be resolved among the three

agencies. In addition to access issues, IRS’ feasibility analysis is to include

an assessment of data accuracy, currency, and completeness—factors that

will be especially important for the custodial data to be useful.

Filing status errors. IRS’ tax year 1994 study showed that a large proportion

of qualifying child errors occurred in tandem with erroneous claims of

head of household status. One of the components of the EIC compliance

initiative involves increased staffing to expand a project aimed at a

universe of about 345,000 head of household EIC claimants whose returns

contain other indicators of potential qualifying child problems. This

project was initiated in 1997 with audits of about 53,000 returns and

expanded in 1998 to 313,000 returns. As of March 1998, about 50,700 of the

53,000 audits begun in 1997 had been closed; and about 43,400 of those

closures (86 percent) resulted in tax changes totaling about $107 million.

On the basis of those results, IRS expects that about 85 to 90 percent of the

1998 audits will result in a change to the EIC claim. According to IRS, results

of these audits will not be available until late 1998 or early 1999. IRS

officials estimated that about 25 percent of the 313,000 audits will be

completed by September 30, 1998.

Errors involving misreported income. Misreported income accounted for

about 16 percent of the total EIC overclaims identified in IRS’ tax year 1994

EIC compliance study. Many of IRS’ traditional compliance activities are

designed to identify returns with misreported income. For example, EIC

returns are subject to IRS’ document matching program, which compares

W-2 wage reports and other income information reports (e.g., those filed

on Form 1099) with income reported on tax returns. Because misreported

income is of particular concern within that segment of the population that

reports self-employment income on Schedule C, the EIC compliance

initiative includes a study of noncompliance among EIC claimants who

report self-employment income. IRS selected a sample of tax year 1997

returns, held the refunds, and plans to complete the audits by September

1998. IRS plans to issue a report of its findings in February 1999.

Page 31 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

Paid preparer noncompliance. The tax year 1994 study data showed that

returns prepared by local or informal preparers had a higher overclaim

rate (31 percent) than the returns prepared by formal preparers

(20 percent). To address preparer noncompliance, TRA97 imposed due

diligence requirements on paid preparers who complete EIC returns and

fines for preparers who fail to comply with those requirements. In

December 1997, IRS issued specific due diligence requirements44 and

publicized these requirements in mailings to practitioners. IRS did not

institute at a national level specific procedures to monitor compliance

with the due diligence requirements during the 1998 filing season.

However, individual field offices may have done some monitoring. At the

Northern California District Office, for example, we were told that staff

phoned about 560 preparers in the district to inform them of the due

diligence requirements and inquired into conformity with those

requirements as part of the district’s normal monitoring visits to about 100

preparers. IRS informed us that national-level plans for the 1999 filing

season include due diligence monitoring visits to EIC return preparers, but

IRS has not decided on the procedures for these visits, the number of visits,

or the extent to which they will target those preparers most likely to be

noncompliant (i.e., local or informal preparers).

As part of the EIC compliance initiative, IRS also planned to increase district

office Criminal Investigation staffing in fiscal year 1998 to investigate

potential EIC fraud cases, including cases involving return preparers. The

increased staffing was to include a total of 40 special agents and 10

investigative aides. For fiscal year 1998 as of May 31, 1998, 31 paid

preparer cases have been opened compared to 44 for all of fiscal year

1997.

Fraud detection. IRS’ QRP is aimed at identifying tax returns with potentially

fraudulent refund claims. The scoring system used to identify these

returns is based on known characteristics of potentially fraudulent

returns. As part of the compliance initiative, IRS expanded QRP staffing to

allow screening of 1.3 million more returns in fiscal year 1998 than in fiscal

year 1997, for a total of 4 million returns. According to IRS, as of April 30,

1998, QRP teams had scanned about 2.3 million potentially fraudulent EIC

44Under these requirements, a paid preparer must (1) complete an EIC eligibility checklist or some

substitute form that contains the same information; (2) complete the EIC worksheet, or keep a paper

or electronic record of the EIC computation that includes the computation method and information

used; (3) not know or have reason to know that any information used to determine EIC eligibility is

incorrect; and (4) retain, for 3 years, a copy of the completed checklist, the worksheet, and a record of

how and when the information was obtained and who provided the information.

Page 32 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

returns and had identified 6,476 returns with erroneous EIC claims totaling

$17.6 million.

Timely Data on the Results

of EIC Compliance Efforts

Would Facilitate

Decisionmaking

As is evident from our discussion of the various elements of the EIC

compliance initiative, there was little information available at the time we

completed our audit work on the results of IRS’ efforts and thus little basis

for us or IRS to assess their effectiveness. Such data and assessments are

crucial as IRS decides on the compliance initiative’s future direction.

An obvious question one would ask in assessing IRS’ results is “how much

has the EIC overclaim rate changed since the start of the initiative?”

Although the results of the tax year 1994 EIC compliance study were the

catalyst behind congressional funding of the compliance initiative, IRS does

not plan to use those results as the baseline for measuring the initiative’s

impact on the EIC overclaim rate. Instead, it plans to measure the

initiative’s impact against the results of a tax year 1997 compliance study,

which IRS has begun as part of the initiative.45 However, by the time IRS

completes the tax year 1997 study, which is to become the baseline, and a

tax year 1998 study that can be compared with the baseline to measure

change, IRS will be in the fourth year of its 5-year initiative. IRS’ time frame

for the tax year 1997 baseline study shows that the analysis will not be

completed until fiscal year 2000. If the tax year 1998 study follows the

same schedule, its results will not be available until fiscal year 2001—the

fourth year of the initiative. It will be too late at that point to make

substantive changes to the initiative.

Given the time frames associated with the broad compliance studies, it is

important that IRS closely monitor the results of the initiative’s individual

components so that it can make more timely and better informed

decisions about revising, deleting, or expanding those various

components. For example, information on the results of the notices IRS

sent users of duplicate SSNs in December 1997 would be useful in deciding

whether to send similar notices in December 1998. As noted earlier,

however, IRS does not plan to begin such an assessment until

September 1998 and does not expect to have final results until well after

December 1998.

45By using tax year 1997 compliance as its baseline, IRS will not be measuring the impact of EIC

changes implemented in tax year 1997 or earlier years.

Page 33 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

Conclusions Although minor methodological problems in IRS’ tax year 1994 EIC

compliance study could have led to some over- or understatement of total

EIC overclaims, these issues do not affect the relevance of the study’s

findings. The study demonstrates that EIC noncompliance is a significant

issue and that verifying qualifying child eligibility lies at the heart of EIC

compliance problems. Targeting compliance efforts at qualifying child

errors, however, presents IRS with a major challenge. IRS is not set up to

systematically verify qualifying child eligibility. Doing so would basically

require IRS to establish a process to verify eligibility before issuing a

refund, similar to the processes used in EIC compliance audits.

IRS’ EIC compliance initiative includes a broad array of customer service,

enforcement, and research activities aimed at reducing noncompliance.

Some parts, like special audits of head of household claimants and

preparer due diligence requirements, are targeted specifically at areas of

noncompliance identified in the tax year 1994 study. Others, like expanded

walk-in and telephone assistance, are more broadly based efforts aimed at

improving taxpayers’ understanding of EIC rules. Although it is too early to

judge the initiative’s effect on noncompliance, we did identify some

opportunities for IRS to improve future implementation efforts. For

example, IRS did not offer Saturday walk-in assistance until late in the

filing season when millions of EIC claims had already been filed. Also, for

the TRA97 provisions allowing IRS to deny future EIC claims to act as a

deterrent, taxpayers must be aware of the circumstances under which

these penalties will be applied. IRS’ income tax return instructions,

however, did not alert taxpayers as clearly as they could have about these

provisions and their implications.

IRS plans to do annual studies to measure the impact of its EIC compliance

initiative on the overclaim rate. Based on IRS’ time frame for these studies,

however, useful data on impact will not be available until fiscal year

2001—the fourth year of the initiative. It will be too late at that point to

make substantive changes. Absent timely data on the overall impact of IRS’

efforts and given the need for IRS to ensure that available resources are

used as effectively and efficiently as possible, it is important that IRS have

immediate information on the results of individual components of that

initiative. Evaluation plans that are not timed to provide data when data

are most needed, as appears to be the case with IRS’ planned evaluation of

the notices on duplicate SSNs, are of limited value.

Page 34 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

Recommendations to

the Commissioner of

Internal Revenue

We recommend that the Commissioner of Internal Revenue

• ensure that customer service efforts aimed at EIC claimants be available

earlier in the filing season when most EIC claims are filed, and

• include prominent information regarding the 2-year and 10-year sanctions

and the recertification process in the Form 1040 EIC instructions and

Schedule EIC.

In addition, to provide a basis for continually improving and refocusing EIC

compliance efforts, we recommend that the Commissioner develop

evaluation plans for each compliance initiative component that will

provide, in succeeding years of the initiative, timely data for

decisionmakers.

Agency Comments

and Our Evaluation

We requested comments on a draft of this report from the Commissioner

of Internal Revenue and the Secretary of the Treasury, or their designees.

The Commissioner of Internal Revenue responded in a July 2, 1998, letter

generally agreeing with our recommendations (see app. I). On July 1, 1998,

we met with IRS officials, including the Deputy Chief of Operations, the

Acting Assistant Commissioner for Customer Service, and the Assistant

Commissioner for Research/Statistics of Income, to discuss the

Commissioner’s comments. Treasury’s Deputy Assistant Secretary (Tax

Analysis) responded in a June 29, 1998, letter (see app. II).

In response to our recommendation that IRS provide customer service

efforts earlier in the filing season, IRS said that it plans to publicize EIC

awareness events early in the 1999 filing season and to hold EIC awareness

activities beginning in January 1999. IRS officials told us that (1) Saturday

service at walk-in assistance sites during the 1999 filing season will begin

on January 16 and continue through the filing season, and (2) the first 6

Saturdays will be publicized as EIC help days. These actions, if effectively

implemented, will be responsive to our recommendation.

In response to our second recommendation about more prominently

displaying information on the 2-year and 10-year sanctions and the

recertification process, IRS said that it will include such information in the

tax year 1998 Schedule EIC instructions but will not revise the schedule

itself. IRS said that it did not believe the Schedule EIC should be revised to

address these issues because the issues do not affect the majority of filers

and providing the information on the schedule may confuse filers who

have not had their EIC claim disallowed. According to IRS officials,

Page 35 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

taxpayers must go to the worksheet in the instructions to complete the

schedule, and IRS’ intent is to place the information so that persons using

the worksheet will easily see it. Although inclusion of the information in

the Schedule EIC instructions is an improvement, we continue to believe

that something should also be added to the schedule. Because one of the

purposes of this information is to alert potential EIC claimants to possible

repercussions if they make erroneous claims, the information affects all

filers. Also, although it is true that taxpayers who choose to compute their

own EIC have to use the worksheet in the instructions, taxpayers who

choose to have their returns prepared by someone else do not have to use

the worksheet and thus would see only the Schedule EIC. We are not

suggesting that all of the information on sanctions and recertification be

included on the schedule. What we are suggesting is that a brief, but

prominent, cautionary statement be added to the schedule alerting users

to important information in the instructions that they should read before

filing their returns.

Regarding our final recommendation, IRS said that it understood our

concern regarding more timely delivery of research data for

decisionmaking. According to IRS, it has developed an information delivery

strategy that includes developing information systems that will allow more

timely delivery of both interim and final tax return, audit, and research

data. The strategy includes using interim reports to disseminate

preliminary findings from various EIC projects. For example, IRS officials

said that they hope to have, in October 1998, some preliminary findings

from audits of taxpayers who had used duplicate qualifying child SSNs. IRS

also noted that using interim data of this sort has limitations; it may not be

adequate to measure revenue or provide a full understanding of taxpayer

behavior. Although there are certain limitations associated with interim

data, we believe, as IRS recognized in its comments, that such data can be

of value to decisionmakers.

Treasury’s letter addressed two statements in the draft report—our

characterization of the EIC as an income transfer program and our

statement that IRS cannot address a significant root cause of

noncompliance. In response to our statement comparing the EIC to other

income transfer programs, Treasury said that “unlike income transfer

programs, the [EIC] makes work pay by reducing tax liabilities,” and that

about 80 percent of the EIC’s total costs offset individual income, Social

Security, and other federal taxes. We clarified our reference to income

transfer programs where appropriate.

Page 36 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
B-278069 

In response to our statement in a draft of this report that IRS cannot

address a significant root cause of noncompliance (IRS’ difficulty verifying

qualifying child eligibility), Treasury said that issues of verifying family

relationships and living arrangements are not unique to the EIC but also

affect taxpayers’ eligibility for dependency exemptions, filing status, the

child credit, and the child and dependent care tax credit. Also, both IRS and

Treasury said that they were hopeful that access to new data (an HHS

registry of child support orders and SSA data linking parent and child SSNs)

will allow IRS to detect some qualifying child problems during return

processing. We modified our statement and related discussions in the

report to acknowledge IRS’ ability to identify some noncompliance related

to qualifying children. Our report also recognizes the provision in TRA97

giving access to the HHS and SSA databases. However, IRS told us that it will

not be testing use of these databases until late 1999 or 2000 and that the

amount of information that can be initially expected is small.

As agreed with your offices, unless you publicly release its contents

earlier, we plan no further distribution of this report until 30 days from the

date of this letter. At that time, we will send copies to the Ranking

Minority Member, Committee on Ways and Means; the Chairmen and

Ranking Minority Members of other interested congressional committees;

the Secretary of the Treasury; the Commissioner of Internal Revenue; and

other interested parties.

Major contributors to this report are listed in appendix III. If you or your

staffs have any questions, please call me on (202) 512-9110.

James R. White

Associate Director, Tax Policy

 and Administration Issues

Page 37 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
Contents

Letter 1

Appendix I 

Comments From the

Internal Revenue

Service

40

Appendix II 

Comments From the

Department of the

Treasury

43

Major Contributors to

This Report

45

Related GAO Products 48

Tables Table 1: Maximum EIC Amounts and Income Limits for Tax Years

1994 and 1997

5

Table 2: EIC Overclaims on Tax Year 1994 Returns by Number of

Qualifying Children Claimed

14

Table 3: EIC Overclaims Involving a Qualifying Child Error, by

Qualifying Child Test Failed, Tax Year 1994

19

Table 4: EIC Amounts Overclaimed by Taxpayers Erroneously

Filing as Head of Household, by Corrected Filing Status, Tax Year

1994

20

Table 5: IRS’ EIC Compliance Actions in Fiscal Year 1998 26

Figures Figure 1: Sources of EIC Overclaim Errors, Tax Year 1994 17

Figure 2: EIC Overclaim Rates for Returns Done by Paid

Preparers, by Type of Preparer, Tax Year 1994

22

Page 38 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
Contents

Abbreviations

AGI adjusted gross income

EIC Earned Income Credit

HHS Department of Health and Human Services

IRS Internal Revenue Service

OTA Office of Tax Analysis

QRP Questionable Refund Program

SOI Statistics of Income

SSA Social Security Administration

SSN Social Security number

TRA97 Taxpayer Relief Act of 1997

Page 39 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
Appendix I 

Comments From the Internal Revenue

Service

Page 40 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
Appendix I 

Comments From the Internal Revenue

Service

Page 41 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
Appendix I 

Comments From the Internal Revenue

Service

Page 42 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
Appendix II 

Comments From the Department of the

Treasury

Page 43 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
Appendix II 

Comments From the Department of the

Treasury

Page 44 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
Major Contributors to This Report

General Government

Division

David Attianese, Assistant Director

Deborah Parker Junod, Evaluator-in-Charge

James Fields, Senior Social Science Analyst

John Lesser, Senior Evaluator

MacDonald R. Phillips, Economist

Robert Dunsky, Economist

Kansas City Field

Office

Doris Hynes, Senior Evaluator

San Francisco Field

Office

Susan Mak, Evaluator

Page 45 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
Page 46 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
Page 47 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
Related GAO Products

Earned Income Credit: Noncompliance Relative to Other Components of

the Income Tax Gap (GAO/GGD-97-120R, June 13, 1997).

Earned Income Credit: Claimants’ Credit Participation and Income

Patterns, Tax Years 1990 Through 1994 (GAO/GGD-97-69, May 16, 1997).

Tax Administration: Earned Income Credit Noncompliance

(GAO/T-GGD-97-105, May 8, 1997).

Earned Income Credit: IRS’ 1995 Controls Stopped Some Noncompliance,

But Not Without Problems (GAO/GGD-96-172, Sept. 18, 1996).

Earned Income Credit: Profile of Tax Year 1994 Credit Recipients

(GAO/GGD-96-122BR, June 13, 1996).

Earned Income Credit: Noncompliance and Potential Eligibility Revisions

(GAO/T-GGD-95-179, June 8, 1995).

Earned Income Credit: Targeting to the Working Poor (GAO/GGD-95-122BR,

Mar. 31, 1995).

Earned Income Credit: Targeting to the Working Poor (GAO/T-GGD-95-136,

Apr. 4, 1995).

Tax Administration: Earned Income Credit—Data on Noncompliance and

Illegal Alien Recipients (GAO/GGD-95-27, Oct. 25, 1994).

Tax Policy: Earned Income Tax Credit: Design and Administration Could

Be Improved (GAO/GGD-93-145, Sept. 24, 1993).

(268815) Page 48 GAO/GGD-98-150 IRS’ Tax Year 1994 EIC Compliance Study
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