Advance Earned Income Tax Credit: Low Use and Small Dollars Paid Impede IRS's Efforts to Reduce High Noncompliance
Published: 2007-08-10T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Advance Earned Income Tax Credit (AEITC) allows individuals to receive a portion of the Earned Income Tax Credit (EITC) in their paychecks, instead of receiving all of it when filing their year-end tax return. Limited research has been conducted on the AEITC since GAO last examined it in the early 1990s. GAO was asked to determine (1) how many individuals received the AEITC compared with the EITC in tax years 2002 through 2004, what actions, if any, have been taken to increase use, and the potential for increases in use in the future; (2) the extent of noncompliance, if any, associated with the AEITC; and (3) how well the Internal Revenue Service's (IRS) procedures address the areas of noncompliance. To address these questions, GAO analyzed Forms W-2 and tax return data and interviewed IRS and Social Security Administration (SSA) officials.
section_title: What GAO Found
paragraphs: AEITC use was low--only about 3 percent of EITC recipients potentially eligible for the advance received it in tax years 2002 through 2004, or about 514,000 of the 17 million potentially eligible individuals each year. About half of all recipients received $100 or less in AEITC and 75 percent received $500 or less for the year, with a total benefit paid of about $146 million each year. Several efforts have been aimed at increasing use over the last approximately 15 years, such as sending notices to individuals informing them that they were potentially eligible for the AEITC and making changes to IRS forms. Despite these efforts, use did not substantially increase and, for several reasons, it may be difficult to increase it in the future. For example, IRS officials, other experts, and prior GAO work suggests that individuals often do not elect the AEITC because they prefer receiving the entire EITC as a lump sum after filing their tax return. As many as 80 percent of AEITC recipients did not comply with at least one of the program requirements GAO reviewed, and some were noncompliant with more than one during the 3 years we reviewed. In tax years 2002 through 2004, about 20 percent, or more than 100,000 AEITC recipients, may not have been eligible for the AEITC because they had an invalid Social Security number (SSN). These individuals received a total of $37 million to $39 million each year. Almost 40 percent (about 200,000 recipients) did not file the required tax return; these individuals received $42 million to $50 million each year. Of the about 60 percent (more than 300,000) AEITC recipients who did file a return, about two-thirds misreported the amount received. IRS's procedures have limited effectiveness in addressing AEITC noncompliance. For example, Automated Underreporter (AUR) staff worked on only a fraction of AEITC cases because of resource constraints and criteria limiting case selection. IRS could address AEITC noncompliance by sending "soft notices" to recipients, requiring employers to verify employee SSNs before providing the AEITC, or creating a Forms W-5, "EITC Advance Payment Certificate," database. Each of these options have advantages, however, they also have potential disadvantages that could limit their effectiveness.

section_title: Letter
paragraphs: Beginning in 1979, eligible taxpayers could elect to receive the Earned  Income Tax Credit (EITC), a refundable credit available to low income  workers, as an advance payment—an option currently found in only one  other federal tax credit. Individuals who elect this option receive a  portion of the EITC from their employer throughout the year with their  regular pay, instead of receiving only a lump sum refund or tax credit  when filing their year end federal income tax returns. The Advance  Earned Income Tax Credit (AEITC) provides employees an immediate  benefit from the credit, which may help them meet their daily expenses by  increasing their take-home pay.
Little has been known about the individuals who receive the AEITC, the  employers who pay it, and compliance with its requirements. Neither the  Internal Revenue Service (IRS) nor the employer is required to confirm the  eligibility of those who elect the AEITC before they receive it. Thus, the  extent of compliance problems related to the AEITC may depend on  factors such as how knowledgeable individuals applying for the AEITC are  about eligibility requirements and how well the IRS addresses various  kinds of noncompliance that the agency may identify only after AEITC  payments have been made.
Limited research has been conducted on the AEITC since we last  examined it in the early 1990s. In 1992, we reported that the percentage of  individuals receiving the EITC in 1989 who also received the AEITC was  low and that many eligible workers were not aware of it. We estimated  that almost half of those who received the AEITC in 1989 and filed a tax  return did not report receiving it and that 45 percent of people whom IRS  records show may have received the AEITC never filed a tax return,  meaning that IRS would have no way of determining their eligibility. We  made six recommendations to the Commissioner of Internal Revenue  designed to increase awareness of the AEITC among eligible individuals  and improve compliance among those who receive it. Appendix I  discusses IRS’s implementation of the recommendations from our 1992  AEITC report.
To provide current information on the AEITC, the Committee asked us to  answer the following questions: (1) How many individuals received the  AEITC compared with the EITC and how much did they receive in tax  years 2002 through 2004? What actions, if any, have been taken to increase  use since 1992 and what is the potential for significant increases in the  future? (2) What is the extent of noncompliance, if any, associated with  the AEITC? (3) How well do IRS’s procedures address any areas of  noncompliance? In addition, the Committee asked us to provide basic  demographic characteristics of AEITC recipients and their employers and  to identify legislative and administrative changes made since our 1992  report, some of which were discussed by IRS in its response to that  report’s recommendations. The information is presented in appendixes I  and III through V.
To answer these questions, we obtained a data file from IRS containing all  Form W-2 “Wage and Tax Statements” that reported AEITC in tax years  1999 through 2004. We performed data reliability tests on this file to  determine whether the data were sufficiently reliable for our intended  purposes and determined that they were. This process involved, among  other things, checking the validity of the Social Security number (SSN) on  the Form W-2, determining whether the AEITC amount was above the  yearly maximum limit, and creating subpopulations in which to conduct  our analyses. Using the Form W-2 data and data from other sources, such  as IRS’s Individual Return Transaction File that contains tax return  information, we compiled relevant demographic characteristics data and  compared AEITC data with EITC data when possible. We also reviewed  administrative and legislative changes as well as relevant reports and  considered these along with our data analyses. To examine actions  intended to increase use and determine the potential for increases in  future AEITC use, we reviewed various reports and literature and  interviewed IRS officials and individuals we determined to be experts. We  also used the Form W-2 and other data to identify areas of noncompliance  by comparing the data to the AEITC requirements. In addition, we  examined IRS’s procedures for processing individual income tax returns  with AEITC and interviewed IRS officials to determine how IRS addressed  noncompliance. Finally, we explored possible remedies for the  noncompliance we identified through literature searches and interviews  with various Department of the Treasury, IRS, and Social Security  Administration (SSA) officials. It was not within the scope of our work to  fully evaluate the potential cost and benefits of these options for reducing  noncompliance. We conducted our work in accordance with generally  accepted government auditing standards from December 2005 through  July 2007. Appendix II provides more detail on the scope and methodology  we used to conduct our work.
subsections: section_title: Background
paragraphs: The EITC was enacted in 1975 and was originally intended to offset the  burden of Social Security taxes and provide a work incentive for low- income taxpayers. It is a refundable federal income tax credit, meaning  that qualifying working taxpayers may receive a refund greater than the  amount of income tax they paid for the year. For tax year 2006, the  maximum amount of EITC a taxpayer could receive was $4,536.
Beginning in 1979, individuals could elect to receive the EITC in advance  payments from their employer during the year along with their regular  pay.  One purpose of the advance payment is to provide employees with  an immediate reward for their work effort rather than forcing them to  postpone receiving the credit until they file their tax returns. To get the  credit, at any time during the year, an employee would complete the Form  W-5 and provide it to his or her employer.
Upon receiving a completed Form W-5, the employer calculates the  amount of the AEITC payment to include with the employee’s pay by  considering (1) the employee’s wages, (2) whether the employee is  married or single, and (3) if married, whether the employee’s spouse has a  Form W-5 in effect with an employer. The AEITC payment to the employee  is considered to be equivalent to the employer making a payment to IRS  for employee income tax withholding and employee and employer Social  Security and Medicare tax.  When employers file their quarterly tax  returns, they show the total payments made to employees on the AEITC  payment line on Form 941, “Employer’s Quarterly Federal Tax Return.”
This amount is then subtracted from the total amount of tax the employer  owes.
At the end of the calendar year, the employer indicates the total AEITC  payments the employee received on the employee’s Form W-2. Employees  are then required to report this amount either on their Form 1040 or Form  1040A tax return. Assuming the employee qualified for the EITC, the  AEITC amount received should be reported on the tax return as other  taxes, which, in effect, subtracts the amount received from the total  amount of any EITC. If the employee did not qualify for the EITC, he or  she is still required to file a tax return, regardless of income level, and the  AEITC amount paid is added to any taxes owed. Figure 1 illustrates this  process and notes the major forms involved.
An individual must meet certain requirements to qualify for the AEITC.  Specifically, an individual must expect to (1) be able to claim the EITC for  the current year (EITC requirements for 2006 are shown in table 1), (2)  have at least one qualifying child, and (3) have earned income and  adjusted gross income below a certain amount for that year. There are  additional requirements that an individual may only have one Form W-5 in  effect at a time and that he or she informs their employer if their spouse  also has a Form W-5 in effect. AEITC recipients can receive up to 60  percent of the EITC benefits for one qualifying child. The maximum  AEITC amount for 2006 was $1,648.
A change in an individual’s personal circumstances after submitting the  Form W-5 could affect their eligibility for both the EITC and the AEITC.  For example, an individual who received the AEITC, separated from his or  her spouse during the year, and used the married filing separately filing  status would not be eligible for the AEITC (or EITC). In such cases, when  the individual files their tax return and reports the AEITC amount  received, the amount would be added to any taxes due or subtracted from  any refund.
section_title: AEITC Use Low and May Be Difficult to Increase
paragraphs: About 3 percent of the EITC recipients potentially eligible for the advance,  about 514,000 individuals on average, elected it in each year, tax years  2002 through 2004, according to data employers reported on the Form W-2.  As shown in figure 2, about 21 million taxpayers received the EITC each  year and of these recipients, about 17 million were eligible for the AEITC.
In total, AEITC recipients received an average of about $146 million in  AEITC for each tax year from 2002 through 2004. Yet, those who elected it  often received relatively few dollars from their employers. As table 2  indicates, about half of all individuals who got AEITC received $100 or less  each year and about 75 percent received $500 or less. Even at $100 per  year, this equates to about $8 a month, or $4 every 2 weeks, and even at  $500 per year, this equates to about $42 a month or $19 every 2 weeks. The  amounts most individuals received were significantly less than the yearly  maximum, and were consistent for the 3 years we reviewed.
The number of individuals who have elected the AEITC has remained low  for many years. For example, between 1990 and 1997, AEITC use never  exceeded 2 percent of qualifying EITC recipients. IRS calculated use based  on tax returns showing receipt of the AEITC divided by the EITC  population that reported at least one qualifying child. Using this same  methodology, use for tax years 2002 through 2004 was relatively the same  at an average of 0.8 percent. Our figures for 2002 through 2004 are higher  than these prior AEITC figures because our figures are based upon the  Forms W-2 that reported AEITC (see fig. 2). Historically, AEITC use has  been based upon the number of individual federal tax returns that  reported an amount on the AEITC line. The historic method excludes  individuals who did not file a federal tax return and individuals who filed a  federal tax return but did not report the AEITC.
Additional demographic data about individuals who elected the AEITC are  included in appendix III. These additional data represent new analysis that  has not been previously available, including each recipient’s filing method,  age, and gender, and each employer’s size.
subsections: section_title: AEITC Use Has Not Increased Significantly Despite Several Targeted Efforts
paragraphs: Use of the AEITC has remained low for many years despite several  targeted efforts to increase it. There have been several federal efforts  targeted to increase AEITC use over the last approximately 15 years,  including both legislative and administrative changes. (A full description  of these changes is included in app. IV.) One significant piece of legislation  was OBRA ’93, which involved the AEITC in two ways: it (1) reduced the  maximum amount of EITC an individual could receive in advance and (2)  required IRS to conduct outreach directly to potentially eligible AEITC  recipients. First, OBRA ’93 reduced the AEITC maximum from 100 percent  to 60 percent of the maximum credit available to a taxpayer with one  qualifying child. This change was made to improve compliance and lessen  concerns that recipients would owe the difference when filing their federal  tax return, which was thought to discourage AEITC use.
Second, OBRA ’93 directed IRS to send notices to taxpayers who were  likely to be eligible for the AEITC for 2 years and directed the Secretary of  the Treasury to study the effect of the notice program on AEITC use. Only  some information is available about the first notice mailing, which  occurred in 1994. For the first notice mailing, IRS mailed Publication  1235, “Advance Earned Income Tax Credit Brochure,” and the Form W-5 to  about 13.5 million taxpayers who were potential AEITC candidates during  tax year 1993 informing them about the AEITC. AEITC use increased  about 1 percent following this effort; however, because other outreach  efforts were ongoing during this time, IRS could not conclude that the  increase was attributable to the notice or any other effort specifically.
In 1997, IRS mailed the notice to about 6 million taxpayers who claimed  the EITC in tax year 1996, but did not report receiving AEITC on their  federal tax return. With this second mailing, IRS created two groups, a test  group of about 60,000 taxpayers that received the notice and a control  group of about 60,000 taxpayers with similar characteristics who did not.  Results from the IRS report indicated that about 1.27 percent (771  taxpayers) of the tax returns in the test group reported the AEITC  compared to 0.51 percent (309 taxpayers) of returns in the control group.  The summary report concluded that further efforts to increase AEITC use  substantially are unlikely to succeed. Further, the study recommended  that notification of EITC recipients about the advance not be repeated.
Some of IRS’s administrative changes include outreach to specific groups  and changes to publications. For example, after our 1992 report, the White  House, the Treasury Department, and IRS conducted extensive EITC and  AEITC outreach efforts, including a 1993 announcement of the AEITC by  President Clinton. Other outreach efforts included IRS contacts with  charitable, social welfare, and minority groups to encourage awareness of  the EITC and AEITC among their memberships. IRS also contacted a  number of employer organizations to encourage them to publicize the  AEITC with their memberships. IRS also made changes to its forms,  developed print and video products, and increased speaker seminars to  inform the public about the AEITC. For example, IRS developed publicity  materials, such as grocery bag and milk carton art, brochures, and posters;  provided information in the Small Business Taxpayer Education Program  guide; and increased outreach speaker seminar efforts.
Presently, IRS continues to conduct outreach about the AEITC as part of  its EITC outreach efforts. IRS focuses its outreach to large employer  organizations or to specific large employers, which then promote the  AEITC to employers or employees.
section_title: Future AEITC Growth Is Unlikely
paragraphs: Increasing AEITC use in the future is unlikely for several reasons, but  perhaps primarily because of potential recipients’ preferences and high  AEITC turnover. Interviews with IRS officials, other experts, and our prior  AEITC work suggest that those eligible for the AEITC prefer receiving the  EITC in a lump sum after they file their federal tax return instead of  receiving relatively small portions spread throughout the year.  Another  reason is that, despite the reduction in the yearly AEITC maximum to 60  percent of the maximum credit available to a taxpayer with one qualifying  child, results from an IRS-funded study using focus groups of EITC  participants and interviews we conducted with experts indicated that  potential recipients continue to have concerns that they would receive  more AEITC than they were ultimately entitled to and that they would owe  the difference when filing their federal tax return.
In addition, AEITC growth is adversely affected by individuals who elect  the AEITC and fail to elect it again, i.e., turnover. As table 3 indicates,  more than half of the individuals who elected the AEITC did so for the first  time since 1999 in either tax year 2002, 2003, or 2004. With the overall  AEITC use remaining relatively constant over the 3 years, this indicates  the large number of yearly first-time recipients was almost equally offset  by existing recipients forgoing the AEITC in a following year. The  percentage of AEITC first-time recipients is much higher than the  percentage of first-time EITC recipients, which is slightly less than one- third. Also, of the individuals who elected the AEITC for the first time in  2002 or 2003, about 28 percent elected it again in the following year, 2003  or 2004, respectively, while the remainder did not elect it again in the  subsequent year. Conversely, only about 98,000 (9 percent) individuals  elected the AEITC consecutively in all 3 years, 2002 through 2004.
section_title: High Noncompliance Exists with AEITC Requirements
paragraphs: Overall, as many as 80 percent of all AEITC recipients did not comply with  or made errors involving one of the three AEITC requirements that we  reviewed, and they received about $282 million when the 3 years, 2002  through 2004, are aggregated. Some taxpayers were noncompliant with  more than one requirement. Those requirements are having a valid SSN,  filing a federal tax return, and reporting the proper amount of AEITC  received on the tax return (see fig. 3).
Specifically, in tax year 2002, we found that individuals were  noncompliant with at least one of three requirements we reviewed 79  percent of the time and they received about $93 million of AEITC. For tax  year 2003 and 2004, individuals were noncompliant with at least one  requirement 78 percent (about $91 million) and 79 percent (about $98  million) of the time, respectively.
Some of the noncompliance we identified could have resulted from IRS or  employer clerical errors or improper reporting by the taxpayer. Therefore,  some of the errors may be correctible or were corrected by filing an  amended return. IRS cannot readily identify the number of amended  returns specifically associated with the AEITC because such returns  combine several credits onto one line. The explanation attached to the  amended return would provide details on the change and any analysis of  the explanation would be a manual process.
subsections: section_title: About 20 Percent of AEITC Recipients Had an Invalid SSN
paragraphs: AEITC recipients are required to provide their employer with a valid SSN  for the Form W-2. As table 4 illustrates, about 20 percent (more than  100,000) of AEITC recipients each year may not have been eligible for the  advance because they did not have a valid SSN on their Form W-2.  Collectively, these individuals received between $37 million and $39  million in AEITC each year. The data are consistent over the 3 years  reviewed.
For purposes of this report, invalid SSNs include instances where the SSN  did not match SSA’s records (i.e., the number was never assigned by SSA)  and the SSN/name combinations reported on the Form W-2 did not match  SSA records. Some of these individuals were likely eligible for the AEITC.  For example, a name/SSN mismatch could include instances when a  woman who receives the AEITC marries and changes her name with her  employer but not with SSA. This could result in the employer issuing a  Form W-2 in the new name, but IRS and SSA only identifying her by the  former name.
Individuals who file a federal tax return are required to include a valid SSN  on their return. An individual who provides an invalid SSN on the tax  return is not compliant in meeting AEITC requirements and may also  violate the Social Security Act. Such an individual is also required to  provide a valid SSN to their employer for income tax withholding purposes  and for purposes of certifying eligibility for the AEITC and could be  subject to a penalty for failure to do so. Further, if the individual does not  file a valid SSN, IRS is unable to assess the recipient’s federal tax liability  and SSA cannot credit the recipient for money withheld for Social Security  purposes. Also, because taxpayers often do not report receipt of the  advance on their tax return, IRS cannot determine whether the taxpayer  owes money or deserves a refund.
section_title: Almost 40 Percent of AEITC Recipients Did Not File the Required Federal Tax Return
paragraphs: All AEITC recipients are required to file a federal tax return, regardless of  the amount of their income, which is generally the primary basis for  determining whether a return is required to be filed. Table 5 shows that  between 36 and 40 percent, about 200,000 AEITC recipients, did not file a  required federal tax return each year. Collectively, these individuals  received between $42 million and $50 million of AEITC benefits.
About 56,000 to 60,000 of the about 200,000 individuals who did not file the  required tax return (about 30 percent) had an invalid SSN on the Form W-2  each year, as shown in table 6. Having a valid SSN is another AEITC  requirement, discussed previously, which means these individuals were  noncompliant or made an error with at least two AEITC requirements.
There are several reasons why a significant number of AEITC recipients  might not have filed a federal tax return. For example, depending on their  filing status, age, and type of income they receive, recipients may not have  had a filing responsibility other than for the AEITC and they may not have  remembered or understood they must file a return. In addition, AEITC  recipients may not have filed because they were not initially eligible or  they became ineligible for the AEITC because of a change in their personal  circumstances, and filing would require them to pay back the AEITC they  received.
When individuals are required to file a federal tax return and do not, IRS  cannot readily identify whether the individual was eligible for the advance  or whether they owed IRS any of the amounts they received. Conversely,  by not filing a federal tax return, some individuals did not receive  additional EITC monies that they could only receive had they filed.
section_title: About Two-Thirds of AEITC Recipients Who Filed a Federal Tax Return Misreported the Amount of AEITC They Received
paragraphs: All AEITC recipients are required to report on their federal tax return the  amount of AEITC they received according to the Form(s) W-2. Reporting  this amount allows the IRS to determine whether the taxpayer received  too much AEITC, and owes money back to the IRS, or whether the  taxpayer is entitled to additional amounts of the EITC.
Of the approximately 60 percent (about 300,000) AEITC recipients who  filed a federal tax return, two-thirds misreported the amount they received  in tax year 2002 through 2004, as shown in table 7. Misreported means that  the total amount of AEITC reported on the Form W-2 does not match the  AEITC amount reported on the federal tax return. Approximately one- third of the federal tax returns correctly matched to the Form(s) W-2  AEITC amount. Of those that misreported, the vast majority did not report  receiving any AEITC.
Taxpayers may not report the amount of AEITC they received because  they either forget or do not know they are required to do so.  Underreporting can occur when there is a computation error involving  multiple Forms W-2, a taxpayer disagrees with the amount reported on the  Forms W-2, or there is willful noncompliance. IRS officials in the AUR  program pursue some AEITC cases where taxpayers either underreport or  do not report receipt of the AEITC. These procedures are discussed in  detail in a following section.
Due to the high number of mismatches, many of the AEITC recipients who  also claimed the EITC likely received excess benefits. For example, of the  222,691 taxpayers who did not report receipt of the AEITC on their tax  return in tax year 2002, almost half went on to claim the EITC. We  determined that those taxpayers received nearly $22 million in excess  AEITC benefits. For the 3 years, 2002 through 2004, taxpayers received a  total of about $64 million in excess AEITC benefits.
section_title: AEITC Recipients Were Noncompliant with Other Program Requirements
paragraphs: Additional noncompliance or errors existed with other program  requirements, such as receiving excess AEITC. Details and demographic  information on the noncompliant individuals are in appendix V.
section_title: IRS’s AEITC Compliance Procedures Have Limited Effectiveness and Options to Better Address Noncompliance Have Advantages and Disadvantages
paragraphs: IRS’s Submission Processing is responsible for receiving, processing, and  archiving the nation’s federal tax returns, payments, and information  returns. In the context of AEITC, Submission Processing attempts to catch  mismatches between both paper and electronic tax returns and Forms W-2  (see fig. 4).
Between 32 percent and 22 percent of tax returns reporting an AEITC  amount were filed on paper between tax years 2002 and 2004, respectively.  If a paper tax return has an entry on either the AEITC or EITC lines on the  Form 1040, Submission Processing tax examiners are required to ensure  that the AEITC amount reported on the return matches the amount in box  9 of the Form(s) W-2, which records the amount of AEITC paid by the  employer to the employee.
If the amounts on the AEITC line of the tax return and Form W-2(s) match,  the tax examiner takes no further action. If the amounts differ (e.g., the  tax return reports a lesser amount than is reflected on the Form(s) W-2)  the examiner is required to adjust the entry on the return to equal the total  AEITC amount from the Form(s) W-2. All paper returns then go to staff  who enter data from the Form 1040 into an electronic database.
After an examiner makes an adjustment, IRS sends a letter to the taxpayer  explaining that an adjustment was made and it was based on the mismatch  between the tax return and the Form(s) W-2. IRS sent 282 and 220 such  letters in tax years 2003 and 2004, respectively. Submission Processing’s  role is to ensure that the return amount is consistent with the Form W-2,  not to determine which of the differing numbers accurately reflects the  amount of AEITC actually paid to the employee. If the taxpayer disagrees  with the adjustment, e.g., believes that the amount on the Form(s) W-2 is  incorrect, the taxpayer can dispute it.
Between 68 percent and 78 percent of returns reporting an AEITC amount  were filed electronically between tax years 2002 and 2004. Submission  Processing runs a computer check to find any mismatches between the  amounts on the electronic tax returns and the electronic Form(s) W-2.  When mismatches are found, Submission Processing rejects the return and  sends it to the taxpayer or preparer to correct and retransmit to IRS.
In most tax preparation software, once a user enters an amount from the  Form(s) W-2, the amount is automatically transferred to the appropriate  line of the tax return. Thus, if the user errs in entering the proper amount  from the Form W-2, the software would enter this erroneous number on  the tax return. As a result, Submission Processing rarely identifies AEITC  tax return/Form(s) W-2 mismatches because the original Form(s) W-2  from the employer(s) is rarely included in electronic filings. IRS rejected  172 electronically filed returns reporting AEITC in tax year 2004 and 147 in  tax year 2003. Adding these mismatches to the paper return mismatches,  Submission Processing found 392 mismatches in tax year 2004 and 429 in  tax year 2003.
Next, Submission Processing sends the return through its Error Resolution  System (ERS) when the AEITC amount on the Form 1040 meets certain  selection criteria. If ERS finds that AEITC exceeds this amount, a tax  examiner matches the Form 1040 AEITC amount to the Form W-2(s). If  they match, no action is taken, and the return is posted in IRS’s Masterfile,  the agency’s central repository for taxpayer information. If there is a  mismatch, IRS adjusts the return to match the Form(s) W-2, and IRS sends  a letter to the taxpayer describing the error and the ERS correction.  Taxpayers who disagree with the change can dispute it. The ERS process  thus serves as a back-up check in case the earlier physical or electronic  processes missed these AEITC mismatches. ERS examined 3,380 tax  returns with AEITC in tax year 2004. IRS was not able to tell us how many  of these returns involved mismatches.
Prior ERS selection criteria would not have identified some returns for  individuals when the Form(s) W-2 had AEITC amounts that were above  the legal maximums, but below the ERS selection criteria. While  interviewing Submission Processing officials, we suggested that the  criteria be modified and associated with filing status. IRS made such  changes to the criteria, effective January 2, 2007.
subsections: section_title: IRS’s Procedures to Verify SSNs Have Limited Effectiveness for AEITC Recipients Due to Taxpayer Noncompliance in Reporting and Filing
paragraphs: Submission Processing’s procedures have limited effectiveness in verifying  that AEITC recipients have a valid SSN because, as previously noted, many  individuals do not file the required tax return and, for those who do, most  do not report receipt of the advance.
For both paper and electronically filed returns, Submission Processing  checks IRS’s Data Master (DM-1) file, which is a database that includes,  among other things, all validly issued SSNs and the individual’s name  associated with each SSN. Submission Processing rejects electronically  filed tax returns with an invalid SSN on the Form 1040, including those  from taxpayers who received the AEITC, and sends back the tax return to  the taxpayer for correction before processing. For returns filed on paper  with an invalid SSN on the Form 1040, Submission Processing processes  the return, but disallows certain credits and exemptions, such as the EITC.  If the taxpayer’s SSN is invalid and the AEITC is claimed on a paper  return, Submission Processing processes any AEITC reported. Since the  AEITC is reported as tax, it will either offset all or part of any refund due  or, if no refund is due, require the taxpayer to pay back the full AEITC  amount.
Thus, of the approximately 514,000 individuals who received the AEITC  each year between tax years 2002 through 2004, Submission Processing’s  procedures would apply to about 118,000 taxpayers—those who filed and  reported receipt of the advance. For nonfilers, Submission Processing  cannot verify SSNs because there are no tax returns—-the basis of its  examination. While Submission Processing performs a SSN verification for  those who file and do not report receipt of the AEITC, it is not effective for  the advance since the advance is not reported on the return.
section_title: Many Taxpayers Underreported AEITC and IRS Worked on a Limited Number of These Cases, Some of Which Submission Processing Did Not Find
paragraphs: After a return has been processed, the next point when IRS might identify  and correct AEITC noncompliance is when it matches tax returns to other  documents it receives. Overall, each year AUR identifies about 14 million  discrepancies between taxpayer income and deduction information  submitted by third parties and amounts reported on individual income tax  returns. AUR has the resources to only work on a fraction of these cases  each year and uses criteria, such as revenue collection potential, for case  selection.
For AEITC, AUR compares the amount of AEITC that employers report on  a taxpayer’s Form W-2 to the amount reported on an individual’s tax  return (see fig. 5). AUR receives this information in separate databases  from SSA and undertakes these comparisons in August and December of  each year—well after Submission Processing has completed its review of  the returns and associated Forms W-2.
Generally, AUR does not take action when the AEITC amounts match the  amounts reported on the return or when the discrepancy does not meet  IRS case selection criteria. For example, for tax year 2003, our data show  that there were about 209,000 tax returns where the AEITC amount did not  match the amount on taxpayers’ Forms W-2, primarily because the returns  failed to report any AEITC or underreported the amount. AUR identified  about 25,000 of those cases in tax year 2003 as potential cases on which to  work.
In tax year 2003, Submission Processing identified 429 instances where the  amount of AEITC reported on the tax return was less than the amount on  the Forms W-2, which was much fewer than the about 25,000 mismatches  detected by AUR that year. The mismatches involving individuals who  filed paper returns and reported receiving the AEITC should have been  caught by Submission Processing because its examiners are supposed to  match the amount reported on the return with the Form(s) W-2. However,  Submission Processing examiners review huge volumes of returns and it  can be a challenge to identify the relatively few with AEITC.
Because AUR does not break down its AEITC cases by filers who  underreport and filers who fail to report any AEITC amount or by filers of  paper versus electronic returns, it is not possible to determine exactly how  many AUR cases should have been caught by Submission Processing. AUR  officials told us that it would be difficult for them to routinely break out  this information in this way because this would require new computer  programming and the budget for new programming requests was reduced  for fiscal year 2007.
In accordance with return processing procedures, if Submission  Processing identifies an underreporter, it reduces the size of the refund  that will be sent to the taxpayer. Thus, using Submission Processing,  rather than AUR, better protects revenue because the erroneous EITC  amounts are never paid to the taxpayer. If AUR works on the case, it  assesses the tax owed, but further IRS action is required to collect the  actual overpayment—through a future refund offset or a current effort to  collect the refund paid erroneously.
Although catching AEITC underreporting in Submission Processing would  better protect revenue than do AUR processes, the benefits to improving  Submission Processing to catch AEITC errors may already be small and  could get smaller. This is because the number of EITC returns filed  electronically is more than 68 percent and has been growing and, as  previously noted, Submission Processing identifies few mismatches for  returns that are filed electronically because the electronic Form W-2 is an  iteration of the user’s entries. In its July 2006 report, the Treasury  Inspector General for Tax Administration recommended that IRS  reemphasize the use of the current AEITC review procedures for paper  returns, but agreed with IRS that it could not implement additional  procedures for electronic returns because IRS is unable to fully verify the  accuracy of the Form(s) W-2 during electronic processing of returns.
AUR worked on about twice as many AEITC cases in tax year 2003 as in  the previous year. The total amount of tax assessed in these cases in tax  year 2003 was more than three times the amount in the previous year, and  the amount assessed per case increased about 71 percent, from $555 to  $947, which is near the average AUR assessment of about $1,000. These  trends were either holding steady or improving for the 84 percent of tax  year 2004 cases for which we had data when we completed our review.  The number of cases in which the taxpayer fully agreed with the  assessment rose from about 29 percent in tax year 2002 to about 41  percent in tax year 2003. The number of cases in which IRS withdrew the  assessment, generally after the taxpayer provided documentation that it  was erroneous, dropped from about 15 percent in tax year 2002 to about 4  percent in tax year 2003.
section_title: IRS Works on a Limited Number of AEITC Nonfiler Cases
paragraphs: As previously noted, from tax years 2002 through 2004, about 40 percent of  the individuals who had a Form W-2 reporting that they received AEITC  did not file a tax return as required by law.
All nonfiler cases, including AEITC nonfiler and other lower dollar nonfiler  cases, are eligible to be worked on by IRS’s Wage and Investment and  Small Business/Self Employed divisions. IRS’s policy dictates that some  lower dollar cases and even some cases in which nonfilers are due a  refund may be worked on to ensure that all kinds of cases have the  possibility of being worked on. Still, a key criterion that IRS uses to  determine cases on which to work is potential revenue or the anticipated  net balance due. The higher this amount, the more likely the case will be  worked on. IRS does not track the total number of nonfiler cases worked  on or the kinds of income or credits taken by the nonfilers whose cases  were worked on. Because IRS selects cases based on these criteria, IRS  officials said they worked on few AEITC nonfiler cases.
Beyond AEITC nonfiler cases potentially being worked on by Wage and  Investment and the Small Business/Self Employed divisions, these cases  are also eligible to be worked on by other IRS programs. For example, the  automated collection system involves calls from IRS staff to taxpayers  asking them to file a return or explain why they believe filing is not  required. IRS’s automated substitute for return program involves  collection staff preparing a tax return on behalf of a nonfiler based on  third-party and other information that IRS has available. Once a return has  been created, IRS can act to collect any taxes due.
During 2005 through 2006, IRS conducted a test to determine whether  receipt of AEITC should be a criterion to determine nonfiler cases on  which to work. The test involved working on cases from tax years 2000  through 2003 for 433 taxpayers drawn from a sample of taxpayers who did  not file a return in tax year 2002, but did receive the AEITC that year, and  whose income was between $35,000 and $50,000 for that year. The cases  were worked on in the same way that IRS works on other nonfiler cases.
In interviews with IRS officials about the AEITC nonfiler test, we found  that the agency’s test plan lacked documentation and detail, such as test  justification, likely costs and benefits, and implementation details. It also  lacked a rationale for some important decisions underlying the test and  some changes implemented after the test began were also not well  documented. In our report on three tests conducted by IRS in 2004 to  address leading sources of EITC errors, we noted that the lack of such  documentation hindered monitoring and oversight and did not foster a  common understanding of the tests among management and staff. One of  our recommendations was that the rationale for key decisions on such  tests be documented, and the Commissioner of Internal Revenue agreed  with that recommendation.
Because IRS had not completed its evaluation of the test as of June 2007,  the agency has not decided whether AEITC should be a criterion to  determine nonfiler cases on which to work. Regardless of the agency’s  decision, however, it is unlikely to significantly reduce the number of  AEITC nonfilers because any increase in cases worked on would likely  represent only a small number of such nonfilers, relative to both the total  number of AEITC nonfilers and all nonfiler cases worked on by IRS.
section_title: Collection Handles Few AEITC Cases
paragraphs: All AEITC cases are eligible to be worked on in IRS’s collection program;  however, it generally does not work on cases involving AEITC because the  amounts involved are below selection criteria that determine which cases  to pursue.
Collection does not keep track of the specific types of income and credits  claimed by the individuals whose cases they handle. Still, collection  officials stated that they worked on few, if any, cases involving the AEITC.  Instead, these cases go into “deferral status,” which means any refund the  taxpayer is due will be reduced until the balance due has been paid off.  Like other taxpayers with an outstanding tax liability, these taxpayers  would also get a notice stating how much they owe.
Collection had an effort under way to work on cases under its selection  criteria by setting up automatic monthly installment arrangements and  notifying taxpayers that they were expected to begin paying what they  owed. Officials said that too many taxpayers ignored the arrangements,  and as a result, the program was determined to be cost prohibitive. The  program was therefore discontinued.
section_title: IRS Audits and Criminal Investigation Identified a Small Number of AEITC Cases
paragraphs: IRS annually audits about 500,000 of the more than 21 million tax returns  that claim the EITC. With only about 3 percent of EITC recipients  potentially eligible for the advance receiving it, only a small number of the  audited returns are likely to involve the AEITC. When IRS audits tax  returns claiming the EITC, an examiner is required to determine if the  taxpayer was eligible for it, whether the taxpayer took the AEITC and, if  so, whether the taxpayer reported the correct amount. If the examiner  determines that the taxpayer was not eligible for the EITC, then the AEITC  is disallowed.
In addition, Criminal Investigation, which investigates potential criminal  violations of the tax code and related financial crimes, has identified six  cases associated with the AEITC since 2001. Five of the six cases involved  refund fraud based on individuals creating fake businesses in order to  obtain the AEITC. The other case involved a business owner attempting to  evade employment tax by falsely signing up employees for the AEITC, but  not including the credit in their paychecks.
section_title: Soft Notices Have Increased Compliance in Situations Similar to AEITC, but Turnover and Difficulty Locating Recipients May Limit Effectiveness for AEITC
paragraphs: Because IRS’s enforcement resources cannot fully cover all areas of  noncompliance, including AEITC noncompliance, the agency has tried to  cost effectively increase voluntary compliance in some areas that involve  relatively small amounts of money by mailing taxpayers soft notices. Soft  notices are letters that ask taxpayers to comply with a certain requirement  in the future or, if the notice informs them that they are not entitled to a  benefit that they received, to file an amended return.
While IRS officials said there have not been any soft notices specifically  targeting AEITC noncompliance, we reviewed the results of three tests  that involved taxpayers who were not filing accurately—many of whom  would not otherwise be subject to an enforcement action. Additionally,  IRS has modified one soft notice test that includes cost estimates. Each of  the completed soft notice efforts show some benefits in improving  compliance, however, they may be less effective for AEITC recipients.
The First Soft Notice Test: The first soft notice—called the “Duplicate  TINs” test—involved different taxpayers claiming the same, or a duplicate,  TIN for a dependent or qualifying child in order to obtain an exemption,  the EITC, or child tax credit benefits. In tax year 2002, IRS identified a  total of about 2.4 million taxpayers who used a duplicate TIN. IRS sent soft  notices to about 820,000 taxpayers.
In November 2005, IRS reported that after receiving the soft notice, 11.4  percent of the population amended their tax year 2002 returns. Other  results focused on taxpayers who received the notice for tax year 2002 and  whether they repeated the use of a duplicate TIN on their tax years 2003  and 2004 tax returns. The results were as follows:    84.9 percent did not repeat their behavior in either of the    7.7 percent repeated the behavior in 2003, but not again in 2004;    4.0 percent did not repeat the behavior in 2003, but did so in    3.4 percent repeated the behavior for both ensuing years.
Although IRS did not report the costs associated with this test, it did  estimate the revenue that would have been lost without the soft notices.  IRS reported that it protected a total of $218.3 million using the Duplicate  TINs test. Due to limitations in the research design, such as not using a  control group, IRS reported that it was uncertain whether these results  were solely influenced by the receipt of a soft notice or if other factors  may have contributed to the change in taxpayer behavior and subsequent  revenue protected. IRS no longer considers this a test and continues to  send out soft notices for Duplicate TINs issued each year.
The Second Soft Notice Test: The second soft notice test—called the  “AUR Soft Notice” test—involved filers who underreported small amounts  of certain categories of income, such as wages, unemployment insurance,  or sales of securities. In December and January 2004 and 2005,  respectively, IRS sent 500 soft notices to randomly selected taxpayers who  underreported income on their tax year 2003 returns. IRS also randomly  selected a control group of 500 taxpayers who underreported small  amounts, but did not send notices to this group.
An outside consultant that IRS hired to determine the effectiveness of the  test reported in October 2005 that (1) soft notices appeared to have a  beneficial result in reducing repeat behavior and (2) IRS resources were  not overburdened by the notices.  Their conclusion was based on several  results. First, after receiving the soft notice, 71 out of the 500 taxpayers  (14.2 percent) filed an amended return. Second, only 33 taxpayers (6.6  percent) who received the notice repeated the underreporting the  following year. In contrast, 174 taxpayers in the control group (34.8  percent) repeated their underreporting. Third, the consultants did not  consider IRS resources to be burdened because only 45 of 500 taxpayers  (9 percent) called IRS with questions. Similarly, the study found there was  limited undeliverable mail—only for 3 taxpayers (0.6 percent). An  additional test was conducted for fiscal year 2006 and had similar positive  results. IRS is in the process of determining whether it will send out soft  notices for AUR in the future.
The Third Soft Notice Test: The third soft notice test—called the  “Dependent Database” test—involved cases selected for three EITC  related issues, including qualifying child, filing status, and Schedule C,  “Profit or Loss from Business,” errors. IRS found that 2.4 million taxpayers  appeared to have had errors on their tax returns. In November 2005, IRS  selected about 12,500 taxpayers to determine the impact of soft notices on  taxpayers’ behavior when filing their tax year 2005 return. About another  12,500 taxpayers were selected as a control group not to receive the  notice.
In its October 2006 report, IRS found that, although there was a difference  between the test group of taxpayers who received the soft notice and the  control group that did not, the direct relationship between receiving a soft  notice and taxpayers’ subsequent filing behavior was weak. Specifically,  the report cited that 88 percent of the test group and 86 percent of the  control group changed their subsequent tax year filing behavior, including  not breaking the same rule, amending the prior year return, or not filing a  2005 return. Specific noteworthy results were:    84 percent of the test group and 83 percent of the control group  filed a return in the subsequent year;    46 percent of the test group and 44 percent of the control group  broke no rules at all;    26 percent of the test group and 25 percent of the control group  broke a different rule;    12 percent of the test group and 14 percent of the control group  repeated their behavior the next year by breaking the same rule;  and    1 percent of the test group and 0.4 percent of the control group  amended their prior-year return.
Also in October 2006, IRS modified the Dependent Database test in both  the Wage and Investment and Small Business/Self Employed divisions to  target notices to another population, i.e., noncustodian person(s) claiming  a child. IRS prepared a preliminary cost analysis for this soft notice test  based on a sample of 300,000 taxpayers. It estimated the total costs of  sending out 300,000 soft notices to be about $533,000, which included  $449,000 for the labor to process amended returns and answer telephone  calls and $84,000 for mailing. Additional information, including the results  of this test, was not available as of mid-June 2007.
Although IRS did not develop criteria for these soft notice tests about  what would constitute a success, such as a self-correction percentage, an  IRS official knowledgeable about the tests said the agency considers the  three completed tests a success, despite the few shortcomings. The first  and second tests were considered successes because they led to  noteworthy changes in taxpayer behavior. The third test was considered a  success because, although taxpayer behavior did not change significantly,  officials considered it a cost-effective way to have an enforcement  presence among these taxpayers. Officials thought that a soft notice test  could be beneficial for reducing AEITC noncompliance as well,  particularly since the amount of money involved with AEITC is low and  the noncompliance might not otherwise be addressed by IRS.
Although soft notices may have some potential to address certain AEITC  noncompliance, characteristics of the AEITC population might make such  notices less effective or more costly than for the test populations for two  reasons. First, AEITC turnover is high. In each tax year 2002 through 2004,  more than half of the individuals were first time recipients. Moreover,  about 73 percent of first-time AEITC recipients in tax years 2002 and 2003  did not elect the AEITC the following year and, thus, would not repeat  noncompliance related to the AEITC. Second, almost 40 percent of  AEITC recipients do not file a tax return, which means that IRS may not  have a current address for those taxpayers. If IRS were to send soft  notices to AEITC nonfilers using the last known address, a significant  number of individuals may no longer reside there. This means IRS might  not be able to locate them or it might spend additional resources trying.
section_title: Federal On-Line SSN Verification Services Could Be Used to Determine AEITC Eligibility, but IRS and SSA Have Raised Concerns
paragraphs: More than 100,000 AEITC recipients had invalid SSNs and reported  receiving millions of dollars in total benefits for each tax year 2002  through 2004 without any substantial check of their eligibility. Because of  the low-dollar amounts involved per taxpayer, IRS worked on only a small  number of these cases. IRS does not have an up-front control or procedure  in place to require employers to verify that an employee seeking the  AEITC has a valid SSN, which could address this noncompliance. Two  federal on-line services have the potential to be used to implement such  controls. Although the services could be used for this purpose, IRS and  SSA officials raised several concerns about implementing such a  requirement.
The TIN Matching service and SSNVS are federal on-line services that  some private organizations may use voluntarily to verify whether federal  records show that the name and SSN provided by an individual match.  TIN Matching is a pre-return filing service offered by IRS that allows those  payers whose income is subject to backup withholding, who submit any of  six Form 1099 information returns (e.g., financial institutions), to match  the TIN of the 1099 payee against IRS records. It is one of several e- service products offered by IRS. The goal of TIN Matching is to improve  the accuracy of Form 1099 data and reduce subsequent inappropriate  penalties and error notices. SSNVS is a service offered by SSA that allows  registered users (i.e., employers or, in certain instances, their third-party  representatives) to verify the names and SSNs of employees against SSA  records. The AEITC is outside the scope of SSA’s responsibilities, and  SSNVS is a voluntary service that is currently used only to increase the  accuracy of wage reporting on Forms W-2.
IRS and SSA officials identified a number of challenges that the agencies  and employers may face if the TIN Matching service or SSNVS were used  to verify AEITC eligibility.
Accuracy: Both the TIN Matching service and SSNVS are based on SSA  records and have high rates of accuracy in terms of determining whether  submitted names and SSNs match. Still, IRS and SSA officials had  concerns about whether these rates were high enough for purposes of  verifying AEITC eligibility. IRS officials told us that the TIN Matching  service is about 98 percent accurate. A December 2006 report by the SSA  Office of Inspector General sampled more than 2,000 determinations by  SSA’s Numident file—the database upon which SSNVS is based—and  found a name and SSN match accuracy rate of more than 99 percent. Still,  SSA officials said that if SSA records were used to verify AEITC eligibility,  they might want to subject an employee’s name and SSN to more  “routines”—procedures such as correcting for transposed numbers that  SSA uses to increase the likelihood of a match—than is currently done by  SSNVS. IRS officials told us that when the agency was informally  considering a proposal to charge a fee for using the TIN Matching service,  several IRS officials knowledgeable about the database opposed the idea  because they did not believe it was accurate enough that users should  have to pay for it.
Accuracy concerns, however, do not preclude IRS or SSA from using SSA  records to make an initial determination about whether individuals who  may claim credits or benefits have demonstrated that they are entitled to  them. For example, as previously noted, IRS rejects electronically filed tax  returns with a name/SSN mismatch and returns them to the taxpayer for  correction. For paper returns reporting AEITC receipt that have a  name/SSN mismatch, IRS processes the returns, but since the AEITC is  reported as tax, it will either offset all or part of any refund due or, if no  refund is due, require the taxpayer to pay back the full AEITC amount.
Similarly, SSA instructs its claims representatives that if the identity of a  claimant for Social Security benefits or Supplemental Security Income  benefits remains questionable because the individual has not provided  sufficient proof to establish his or her identity, the claim will be denied  even if other factors of eligibility are met.
Additional employer responsibilities: IRS and SSA officials said a  major concern about employers using either service was whether a  name/SSN mismatch would create new responsibilities for employers  beyond informing the employee and denying the AEITC. IRS officials also  expressed concern that requiring employers to use the services for AEITC  would discourage them from promoting the AEITC and perhaps encourage  them to dissuade employees from seeking it. Under current procedures for  using the TIN Matching service and SSNVS, employers are not required to  take any action based on the results they receive.
IRS officials expressed concern that a June 2006 regulation proposed by  the Department of Homeland Security could expressly list employer  receipt of a “no match” letter from SSA as possible evidence that the  employer knew or should have known that it was employing an individual  not authorized to work in the United States. Under the proposed  regulation, if the employer fails to take reasonable steps to resolve the  discrepancy after receiving the letter, the Department of Homeland  Security may find that the employer had such knowledge and assess civil  monetary penalties against the employer.
The proposed Department of Homeland Security regulation describes  “safe harbor” procedures that the employer can follow in response to the  letter. Those steps include the employer promptly checking its records for  clerical errors and obtaining required documentation by working with the  employee, SSA, and the Department of Homeland Security. If the  name/SSN mismatch cannot be resolved, the employer would have to  choose between terminating the employee or facing the risk that the  Department of Homeland Security may find that the employer knew that  the employee was not authorized to work and, by continuing to employ the  individual, violated the law.
While the proposed Department of Homeland Security regulation covers  only no match letters, IRS and SSA officials expressed concern that the  regulation could be expanded to include name/SSN mismatches disclosed  by the TIN Matching service or SSNVS. Under current law, existing and  prospective users who are concerned that matching could be used for  purposes beyond improving the accuracy of Form 1099 data or wage  reporting can voluntarily cease using, or not start using, the systems. IRS  and SSA officials noted, however, that employers would no longer have  this choice if they were required to use one of these services to verify an  AEITC applicant’s SSN.
In addition, existing Department of Homeland Security guidance for  employers on the interaction between antidiscrimination laws and legal  requirements for verifying employment eligibility states that employers  must treat all employees in the same manner. Employers cannot set  different employment eligibility verification standards or require that  different documents be presented by different groups of employees. If  mandatory verification of AEITC applicants’ SSNs created additional  employer responsibilities under employment eligibility verification  requirements, this result could be inconsistent with efforts to ensure that  verification procedures apply to all employees.
SSA’s position on SSNVS is that a name/SSN mismatch does not make any  statement about an employee’s immigration status and should not be a  basis for taking any adverse action against the employee. SSA officials also  expressed reservations about SSNVS results being used to terminate  employees.
Capacity and User Access: IRS and SSA officials said changes to the  capacity and user access of the TIN Matching service or SSNVS would  either be unnecessary or minor if employers used them to verify SSNs of  employees seeking AEITC, although the officials said their agencies might  favor creating a new service for this purpose instead. They told us that  their systems have the capacity to handle the increased volume of requests  that would result from this expanded use. Because both services already  are used to verify SSNs, IRS and SSA said any changes to how the services  are accessed and used would also probably not be extensive.
Both SSNVS and TIN Matching are Web-only services. To use one of the  services, the employer designates one or more employees or third-party  representatives to register on behalf of the employer. The initial  registration for both the TIN Matching service and SSNVS is handled in a  similar way and may take as long as 4 weeks:    Registrants go to the agency’s Web site and provide information  about themselves and their employers on a form, which they  send electronically to the agency.
The agency sends the employer of the registrant a unique code.
The letter directs the employer to provide that code to the  registrant.
After receiving the code, the registrant can go back to the  agency Web site and input the code to activate use of the  service.
TIN Matching registrants who do not use it for 6 months must reregister,  primarily to receive a new password and update any of the information  provided during the registration. SSNVS requires registrants to change  their password once a year to keep it from expiring, which also requires  reregistration.
IRS and SSA officials told us that the great majority of users of their  respective services generally report that they are not difficult to use for  either the registration process or ongoing use. IRS officials said users  access TIN Matching voluntarily and that some, particularly from smaller  organizations, appear more likely to find it burdensome than users from  larger organizations. We found that more than half the employers that  provided the AEITC in tax years 2002 through 2004 were small businesses  or self- employed and about one-quarter were tax exempt and government  entities. In addition, despite IRS’s efforts to outreach to large employers,  fewer than one-fifth were large and midsize employers (see table 20 in app.  III). IRS officials said TIN Matching service users who found the  registration process burdensome were generally those who reported to  IRS that they were not use to filling out forms on-line and creating and  using passwords. The officials also said that some TIN Matching users  reported being uncomfortable having to provide personal information to  register.
SSA officials said SSNVS is used mostly by larger employers, and a  relatively small number of them reported that they found the service  burdensome. SSA officials did say, however, that SSA received about  89,000 calls through June 2007 from individuals about registration. And, an  SSA official said that small business representatives with whom he has  recently spoken expressed frustration with the overall number of tasks  that the federal government was already requiring them to perform and,  therefore, might be reluctant to verify SSNs.
IRS officials also told us that the TIN Matching service is not programmed  to track users, which likely would be useful to IRS for enforcement  purposes. Still, IRS officials added, that the service could be modified to  track employers that used the services for AEITC purposes and report on  the results. SSNVS tracks its users to determine whether the service is  being properly used.
Additional resources: IRS and SSA officials said that if employers were  required to begin using their respective services to verify the SSNs of  employees seeking the AEITC, the agencies would need additional  resources. For example, officials from both agencies cited the need to  handle questions from new users, particularly in the first year when all  individuals seeking the AEITC would be required to have their names and  SSN’s matched.
When we told IRS officials that our data showed that about 50,000  employers had at least one AEITC recipient, they said such an increase in  the number of registrants could require IRS to increase the number of staff  available to answer user questions. But they said they could not estimate  how many more staff would be necessary.
IRS officials also said they were trying to make the reregistration process  easier because they received a substantial number of calls from users who  needed to reregister. This would be important for AEITC-related use of  TIN Matching because employers with only one or two employees seeking  the AEITC would only need to use the service once or twice a year,  making it likely that they would have to reregister.
SSA officials told us that if the agency was considering or was directed to  make its SSN records available for the purpose of verifying AEITC  eligibility, SSA would have to devote additional resources to conduct a  comprehensive assessment to determine the changes necessary to SSNVS  to properly achieve this goal, including possibly creating a different  service for assessing AEITC eligibility and buying a new database server to  handle the increased volume of users. Again, SSA officials could not  estimate how many more staff would be necessary.
New federal legislation: Enactment of federal legislation would be  needed for employers to begin using the TIN Matching service to verify the  SSNs of their employees seeking the AEITC. In 2000, the Department of  the Treasury recommended to the Congress that TIN verification be  expanded to include other payers subject to an IRS reporting requirement,  such as employers who file Forms W-2.
It is uncertain whether IRS could require employers to use SSNVS to verify  the SSNs of employees seeking the AEITC. SSA officials said they would  need to determine whether SSA’s disclosure of SSN data is compatible  with the reason it collected the information and, if so, whether verifying  SSNs via SSNVS for purposes of AEITC eligibility is consistent with SSA’s  legal obligations. Both Treasury and SSA officials said their agencies  would strongly prefer enactment of legislation before requiring employer  or any verification of SSNs of employees seeking the AEITC.
Employee appeal of mismatch: One difference between using the TIN  Matching service or SSNVS would occur when an employee claimed that a  name and SSN mismatch was inaccurate. IRS and SSA officials said  employees who questioned a SSN mismatch would presumably contact  IRS, which would send them to SSA to resolve the issue because the TIN  Matching service is based on SSA records. IRS officials said that, in  contrast, employees questioning a name and SSN mismatch generated by  SSNVS would presumably go directly to SSA.
Agency mission: SSA officials also said that verifying eligibility for the  AEITC is most appropriate for IRS because it is a tax administration issue  and is therefore outside the scope of SSA’s mission. However, it is not  unusual for agencies to assist other federal agencies in carrying out their  mission. SSA officials also said that, regardless of which service was used,  IRS would have full administrative responsibility for overseeing a program  for employers to verify AEITC applicants’ SSNs.
section_title: IRS Does Not Require Submission of Forms W-5 from Employers for Employees Seeking the AEITC
paragraphs: IRS does not require employers to submit a Form W-5 when an employee  requests receipt of the AEITC. Several advantages and disadvantages exist  if IRS creates a Form W-5 database to use in monitoring AEITC  noncompliance issues.
IRS could require employers to submit a Form W-5 when an employee  requests receipt of the AEITC. In turn, IRS could use the Forms W-5 to  create a database to monitor the AEITC. The database could be used to  ensure that the SSN provided on the Form W-5 is valid and that it matches  the individual’s name. Doing such a check could have prevented more than  100,000 individuals from receiving as much as between $37 million and $39  million each year in AEITC to which they were potentially not entitled  because of not meeting the valid SSN requirement. Such a database could  also allow IRS to know which individuals received the AEITC and provide  the agency with an opportunity to send recipients a notice at the start of  the next filing season reminding them to file a federal tax return. A  reminder to file notice could likely reduce noncompliance for up to about  200,000 individuals who received between $42 million and $50 million each  year in AEITC without filing a federal tax return. Similarly, IRS officials  could use a W-5 database to verify other AEITC requirements, such as  ensuring that each recipient has only one Form W-5 in effect at a time.  This check could reduce the probability that individuals would receive  more than the yearly AEITC maximum.
While acknowledging that potential advantages exist to developing and  maintaining a Form W-5 database, IRS officials said that the disadvantages  could outweigh these and any other advantages. Although IRS officials  said it was too early in the proposal process to calculate the database’s  potential costs and subsequent return on investment, they said it very  likely would be substantially lower than the return on investment for  either existing or anticipated future noncompliance programs. For  example, IRS estimates the current return on investment for EITC  Examination noncompliance is between $17 to $1 and $19 to $1. Although  these amounts only include labor and do not include overhead such as  facilities, equipment, and supplies, officials felt confident that the EITC  return on investment would far exceed that for the AEITC. Their opinion  was largely based on the few dollars involved with the AEITC, especially  compared to other noncompliance programs.
In addition, IRS officials expressed concerns that employers would not  submit Forms W-5 to IRS. Officials raised an analogy between this  proposal and the prior Questionable W-4 program. As we reported in  2003, about 75 percent of the large employers with 1,000 or more  employees in IRS’s Large and Medium-Size Business and Small  Business/Self Employed divisions who filed tax returns in tax year 2001  did not send IRS any questionable Forms W-4. After our report, IRS  discontinued the Questionable W-4 program. Additionally, officials noted  that requiring employers to submit Forms W-5 may discourage them from  participating because if the employer was notified that the SSN on a Form  W-5 was invalid or that it did not match the employee’s name, employers  would likely have a responsibility to discuss the matter with the employee,  creating yet another new burden employers would not want to accept.  Finally, employers may not participate because if the employee left the  employer during the year, the employer would again have to contact IRS  so the Form W-5 database could be updated.
section_title: Options to Reduce AEITC Noncompliance May Be Cost Effective
paragraphs: Although we do not know how successful the various options we have  identified for improving AEITC compliance may be if implemented or  what the full cost of implementation would be, IRS may be able to achieve  a return on investment somewhat comparable to that for EITC  examinations. We found an average of about $94 million a year in AEITC  noncompliance for recipients in tax years 2002 through 2004. If a  compliance effort could reduce AEITC noncompliance by one-quarter, that  is, $24 million per year, IRS could spend about $1.3 million each year to do  so and achieve a $19 to $1 return on investment. Alternatively, IRS  estimated that it would cost about $533,000 to send soft notices to 300,000  taxpayers during the Dependent Database test. If IRS were to test sending  soft notices for AEITC and it cost IRS about the same amount to send  notices to 300,000 noncompliant AEITC recipients, IRS would only need to  reduce AEITC noncompliance by about 11 percent (about $10 million) to  achieve a $19 to $1 return on investment.
section_title: Eligible Taxpayers Could Receive Full EITC Benefits If the Advance Option Were Discontinued
paragraphs: If the advance option were discontinued, eligible AEITC recipients could  still receive the full benefits of the EITC as a lump sum after filing their tax  return. In addition, improper AEITC payments to ineligible or  noncompliant individuals would be eliminated. The exact amount of  revenue that could be saved is not known. However, in determining an  amount, IRS officials said they would consider the following: the amount  of AEITC disbursed compared with the amount shown on filed tax returns,  the cost of administering the AEITC (e.g., forms and publications,  processing, compliance activities), and any amount currently recovered  through compliance activities.
section_title: Conclusions
paragraphs: The AEITC has never achieved a significant participation rate, the amount  recipients received in the period we reviewed was quite low, and  noncompliance was high. However, policymakers may judge that the goal  of providing funds to low-income workers during the year, as opposed to a  lump sum that they could get as part of the EITC when filing their taxes,  remains important and should continue to be allowed. If so, IRS needs to  pursue potentially cost-effective measures to address AEITC  noncompliance.
Each of the three options we identified for improving AEITC  compliance—using soft notices, having up-front verification of AEITC  applicants’ SSNs by employers, or requiring employers to submit copies of  the Form(s) W-5 and creating a database to monitor AEITC—appears to  have potential to improve compliance, but their full benefits and costs  need to be evaluated and, if possible, tested. Soft notices have improved  compliance in other tax programs but they could be somewhat less  effective in improving AEITC compliance, in part, due to its high turnover  rate. The TIN Matching service and SSNVS have the potential to reduce  AEITC noncompliance by enabling employers to verify workers’ SSNs  before providing them the AEITC. Differences exist between the two  services, but either could likely be used for AEITC SSN verification. Both  services are based on SSA records that are already deemed accurate  enough such that SSA and IRS make decisions based on them to disallow  certain exemptions and credits until eligibility has been properly  demonstrated. Significant concerns exist, however, such as the need for  legislation authorizing either the use of TIN Matching or SSNVS for AEITC.  This and other issues would need to be further explored as the costs and  benefits of employers verifying employees’ SSNs are fully identified. If IRS  required employers to submit copies of the Form W-5 when an employee  requests the AEITC, IRS could create a database to better monitor and  address all three of the noncompliance problems we analyzed. However,  imposing additional responsibilities on employers for both the SSN  verification option and the Form W-5 database option have the potential to  adversely affect the AEITC’s already low participation rate if employers  avoid providing the AEITC due to increased responsibilities on their part.
Due to the relatively small size of the AEITC overall, combined with the  low dollar amounts per taxpayer, IRS officials are concerned that  addressing AEITC noncompliance may provide less return on IRS’s  enforcement efforts than would addressing other noncompliance issues.  However, IRS may be able to achieve returns on AEITC enforcement that  would not be significantly out of line with returns on other enforcement  work. For example, it cost IRS about $533,000 to send soft notices to  300,000 taxpayers in the Dependent Database test. If IRS were to test  sending soft notices for AEITC and it cost IRS about the same amount to  send notices to 300,000 noncompliant AEITC recipients, IRS would need  to reduce noncompliance by about 11 percent (about $10 million) to  achieve a $19 to $1 return on investment.
section_title: Recommendations for Executive Action
paragraphs: The Acting Commissioner of Internal Revenue should analyze whether any  of the following options could cost effectively and significantly reduce  AEITC noncompliance:    sending potentially noncompliant AEITC recipients soft notices,  such as to nonfilers whose Forms W-2 show that they received  AEITC and filers who misreported the amount they received or  whose SSN and name do not match;  requiring employers to verify the SSN of employees seeking  AEITC; or  requiring employers to submit Form W-5 to IRS and IRS  creating and maintaining a database for these forms.
To better identify the costs and implementation issues as well as the  likelihood for these or other options to reduce AEITC noncompliance,  where practical, the Acting Commissioner of Internal Revenue should test  these options to make a more fully informed judgment about whether any  would be worthwhile.
If the Acting Commissioner of Internal Revenue determines that none of  these options would be cost effective and no other remedies are viable,  then the Treasury Secretary should inform the Congress of this and  provide Treasury’s opinion about whether the AEITC should be retained.
section_title: Agency Comments
paragraphs: The Acting Commissioner of Internal Revenue provided written comments  in a July 18, 2007 letter. He agreed with our recommendation and outlined  the actions IRS would take to address that recommendation, including  conducting further analyses and possible testing of proposed options for  reducing AEITC noncompliance. He also stated that IRS will conduct its  cost-benefit analyses in conjunction with a congressional requirement to  study the impact of expanding eligibility of the AEITC to all EITC  recipients. We also provided a draft of this report to the Department of the  Treasury and SSA and incorporated technical comments where  appropriate.  SSA emphasized that verifying eligibility for the AEITC is  most appropriate for IRS because it is a tax administration issue and  therefore outside the scope of SSA’s mission.
As agreed with your offices, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days after its  date. At that time, we will send copies of this report to the Secretary of the  Treasury, the Commissioner of the Social Security Administration, the  Acting Commissioner of Internal Revenue, appropriate Congressional  committees, and other interested parties. This report is available at no  charge on GAO’s web site at http://www.gao.gov.
If you or your staffs have any questions, please contact me at (202) 512- 9110 or brostekm@gao.gov.
section_title: Appendix I: IRS’s Implementation of Recommendations from GAO’s 1992 Report on the Advance Earned Income Tax Credit
paragraphs: After analyzing IRS’s responses to our recommendations in our 1992  Advance Earned Income Tax Credit (AEITC) report, we determined that  IRS has implemented five of the six recommendations to the  Commissioner of Internal Revenue from our 1992 report on the AEITC and  partially implemented the remaining one (see table 8).
Our first recommendation was for the Commissioner of Internal Revenue  to include information on AEITC in employee outreach materials and  programs. IRS implemented this recommendation primarily by developing  publicity materials (i.e., grocery bags, milk carton art, brochures, posters)  and distributing them to the public.
For the second recommendation, IRS stated that it did not have the  approximately $2 million in funding that the agency said would have been  required to notify all taxpayers who receive the EITC, but did not elect the  advance option. Instead, IRS took other actions including revising the  Form W-2 in 1992 to contain information on how to apply for the AEITC  and IRS Notice 797, “Possible Federal Tax Refund Due to the Earned  Income Credit,” to include information on how to apply for the AEITC.
For our third recommendation, IRS noted that it could encourage  employers to make such notifications, but that there are no statutory  sanctions on employers who fail to do so. Beginning in 1992, IRS placed  text on the face of the Form W-4 instructions advising employees to  consider filing a Form W-5 with their employer to obtain the advance  through lower withholding.
For our fourth recommendation to clarify instructions on the AEITC in  “Circular E, Employer’s Tax Guide” IRS did so through the inclusion of  new examples explaining to employers how they should make advance  payments to employees and how employers can report these amounts.
Our fifth recommendation was for the IRS Commissioner to send  individuals who received the AEITC and do not file tax returns a notice  explaining the requirement to file. IRS partially implemented this  recommendation by including information on advance payment in a  reminder to file notice and adding a separate AEITC box on Form W-2. IRS  did not track the number of AEITC nonfilers who received the notice. The  reminder to file notice was only sent until 1997 and IRS officials were  uncertain why that notice was discontinued.
The last recommendation was for exploring ways to identify those  individuals who receive the credit in advance but do not report it. IRS  pointed out that its systems were not geared to detecting unreported  AEITC payments at the time the returns are processed and the best  approach to preventing noncompliance by AEITC payment recipients is a  proactive one that recognizes the filing of correct returns. IRS  implemented this recommendation by providing a separate line on Form  1040 on which to report AEITC payments and redesigning the Form W-2,  for tax year 1993, which it believed would increase the accuracy of the  AEITC payment information reported on Form W-2. Our work in this  report demonstrates a continuing need to explore additional compliance  initiatives aimed at those who receive the AEITC, but do not report it on  their tax return.
section_title: Appendix II: Scope and Methodology
paragraphs: To answer the first and second objectives:    how many individuals received the Advance Earned Income Tax Credit  (AEITC) compared with the Earned Income Tax Credit (EITC) and  how much did they receive in tax years 2002 through 2004; what  actions, if any, have been taken to increase use since 1992; and what is  the potential for significant increases in the future; and    what is the extent of noncompliance, if any, associated with the AEITC; we obtained a data file of all Forms W-2, “Wage and Tax Statement,” for  tax years 1999-2004 indicating AEITC payments as shown by an amount  greater than $0 in box 9 of the Form W-2 from the Internal Revenue  Service (IRS). We used these tax years because they were the most  current available at the time we started our review. The Form W-2  identified key information, including the AEITC recipient’s name, address,  Social Security number (SSN), and amount of AEITC dollars paid, as well  as the employer’s name and address.
To determine the number of individuals who received the AEITC, we used  Forms W-2 instead of tax returns, which IRS has historically used to  estimate AEITC use. We used this alternate approach because we believe  the Forms W-2 provide results that are more accurate and complete. For  example, using Forms W-2 would include in the population of AEITC  recipients those who received AEITC, but did not file a return, and those  who filed a return, but did not report any AEITC. Using tax returns would  not capture these individuals or related noncompliance issues. In addition,  using tax returns counts instances where both spouses receive the AEITC  and file jointly on one return as opposed to two individuals. IRS’s  Research, Analysis, and Statistics and EITC program office officials agreed  with our methodology.
We performed data reliability tests on the data file to determine whether  the data were sufficiently reliable for our intended purposes. We did this  testing, in part, by conducting preliminary analyses, which identified  certain data irregularities or anomalies. We identified two noteworthy  anomalies in the data file: (1) excessive AEITC dollar amounts and (2)  invalid AEITC recipient SSNs. First, many Forms W-2 showed that  employees received amounts over the allowable limits. A few even showed  individuals each receiving about $1 million in AEITC—amounts clearly  above AEITC legal limits and which IRS officials said would be  improbable, potentially resulting from transcription errors. Second, we  also found some instances where the SSN and/or name on the Form W-2  were invalid, which means that the number was never issued by SSA or  that the name and number on the Form W-2 did not match the listed name  for that same SSN in official records maintained by IRS. We compared the  number and name information on the Form W-2 to the National Account  Profile to evaluate the validity of that information and to identify any  possible subsequent corrections.
To address these data anomalies, we separated the Form W-2 file into four  subpopulations using the following three criteria: whether (1) the SSN on  the Form W-2 was valid, according to Data Master File (DM-1); (2) the SSN  and the recipient’s name on the Form W-2 matched, according to DM-1;  and (3) the amount of AEITC received was in excess of the yearly  maximum. Each of the subpopulations had a unique profile, as follows:1.  Valid subpopulation: This group of Forms W-2 represents all  individuals (1) that had a valid SSN, meaning that it was a number  issued by SSA, (2) whose name matches the SSN, and (3) that had an  AEITC amount within the yearly maximum. More than 75 percent of  the Forms W-2 on average during tax years 2002 through 2004 were in  this subpopulation.  2.  Invalid name subpopulation: This group of Forms W-2 represents all  individuals that had (1) a valid SSN (2) a SSN that did not match the  individual’s name and (3) the AEITC amount was within the yearly  maximum. About 17 percent of the Forms W-2 fell in this  subpopulation for each of the 3 years we reviewed.  3.  Invalid number subpopulation: This group of Forms W-2 represents  all Forms W-2 that had an invalid SSN and an AEITC amount that was  within the yearly maximum. About 7 percent of the Forms W-2 during  tax years 2002 through 2004 were in this population.  4.  Dollar limit subpopulation: This group of Forms W-2 represents all  instances where the AEITC amount was above the yearly maximum,  regardless of whether the SSN was invalid or if the individual’s name  matched the SSN. This represented less than 1 percent on average of  all Forms W-2 in each of the 3 years we reviewed. Because IRS officials  told us these data were likely erroneous, we excluded it from most of  our analyses, and IRS officials agreed.
We conducted additional data reliability tests for each of the databases we  used to obtain information about the AEITC, including IRS’s Individual  Returns Transaction File, for return and filing information, which came  from the Compliance Data Warehouse; National Account Profile/DM-1, for  IRS’s SSN and name reference information, which also came from the  Compliance Data Warehouse; Automated Underreporter (AUR), for IRS’s  third-party information return data; and Taxpayer Identification Number  (TIN) Matching and SSA’s Social Security Number Verification System  (SSNVS), for alternative SSN and name reference information used by  employers. After completing our data reliability assessments, we  determined the AEITC data to be sufficiently reliable for analysis and our  reporting objectives.
We also developed a comprehensive analysis plan that included our  researchable issues, planned analysis, data sources, and limitations. We  shared our plan with IRS and others and incorporated their feedback.  Because IRS’s workload precluded them from providing information  related to employers/AEITC payers within our time frames, we were able  to conduct only limited analyses of employers who paid AEITC.
Using the analysis plan for each subpopulation, we conducted multiple  analyses to develop relevant demographic, characteristic, and compliance  data. Because each population had different criteria, certain  characteristics or compliance data could not be developed or compared  across the subpopulations. For example, the only characteristics data that  could be developed for the invalid SSN subpopulation came from the Form  W-2 (e.g., amount of AEITC, geographic location) because it is the only  available source. Similarly, tax return data, such as filing status, was not  available for those who did not file a tax return.
All data pertaining to filed tax returns came either from returns that  reported receipt of the AEITC on the appropriate line or from a  “constructed tax return,” which IRS officials created using the SSN on the  Form W-2 and matching it to an SSN in the primary, secondary, or  dependent position on a filed return. The location of the SSN in one of  these positions is relevant due to the way IRS manages its data files. There  could be instances when a tax return was filed but it was not detected  using our methodology. For example, a taxpayer’s SSN on the Form W-2  might have been incorrect and the taxpayer reported the correct number  on the tax return (Form 1040).
To report on data pertaining to the EITC, we relied on published EITC  data provided by IRS research and program office officials, including the  EITC database, the EITC Database Year to Year Comparison Report, and  EITC Fact Sheet.  When possible, our analysis compares individuals who  received the AEITC with individuals who received the EITC. IRS defines  EITC recipients by the number of federal tax returns that received EITC.  In addition, EITC data are based upon the primary TIN of all taxpayers  who received an amount of EITC. We determined the number of  individuals who receive the AEITC based on the number of Forms W-2  reporting AEITC per unique SSN. IRS officials agreed that even though  these populations are not identical, it is reasonable to make a comparison  between them.
We frequently consulted with IRS officials on the data and our analyses;  they generally agreed with both the approach and the accuracy of the  results. For the analyses that IRS conducted, we agreed with both the  approach and the accuracy of the results.
In addition, we reviewed legislative and IRS administrative changes to the  AEITC since 1992 and discussed them with IRS and other officials,  including Department of the Treasury officials. We reviewed reports on  IRS’s implementation of some of our prior recommendations pertaining to  the EITC and discussed them with IRS officials, including the National  EITC Director. We also coordinated this work with the Treasury Inspector  General for Tax Administration.
Finally, we also identified and interviewed 11 individuals we determined to  be experts to provide us a fuller understanding on the potential for  significant increases or improvement to AEITC use and noncompliance  and included academics, researchers, practitioners, and individuals  representing the areas of tax policy, low-income individual issues, and  compliance issues. We chose these individuals based on our knowledge of  their areas of expertise and our research that indicated they were  knowledgeable about the EITC.
To address the third objective, how well do IRS’s procedures address any  areas of noncompliance, we examined portions of IRS’s Internal Revenue  Manual and interviewed IRS Wage and Investment and Small  Business/Self-Employed division officials to determine procedures for  processing returns that reported receipt of the AEITC. We examined how  IRS’s enforcement procedures and operations, including Submission  Processing, AUR, Nonfiler, Collection, Examination, Criminal  Investigation, and Taxpayer Advocate, address certain kinds of potential  noncompliance.
We explored various options to improve AEITC compliance. This involved  conducting literature searches and interviews with IRS and SSA officials.  We reviewed and discussed the results of soft notice tests with IRS  officials, including the National EITC Director, and discussed the  applicability of soft notices for addressing AEITC noncompliance. We also  reviewed and analyzed documents and reports about IRS, SSA, and  Department of Homeland Security databases about whether they could be  used by employers to verify the SSN of an employee seeking the AEITC  before the employer begins paying it. We also interviewed knowledgeable  officials at IRS and SSA about the advantages and disadvantages of such  systems when considering the AEITC. Further, we interviewed IRS  officials from various offices, such as EITC Program, Modernization and  Information Technology Services, and Stakeholders, Partnership,  Education and Communication, about the advantages and disadvantages  of creating a database for the Forms W-5. It was not within the scope of  our work to fully evaluate the potential cost and benefits of these options  for reducing noncompliance.
We also reviewed prior GAO, IRS, Treasury Inspector General for Tax  Administration, and other reports on the AEITC and EITC.
We conducted our work primarily in Washington, D.C., and Atlanta, Ga.,  from December 2005 through July 2007 in accordance with generally  accepted government auditing standards.
section_title: Appendix III: Demographic Characteristics of Advance Earned Income Tax Credit Recipients and Their Employers
paragraphs: We identified basic demographic characteristics of Advance Earned  Income Tax Credit (AEITC) recipients and their employers in tax years  2002 through 2004. Specifically, we identified the following 11  characteristics: (1) number of Forms W-2 received; (2) average amount of  AEITC received by consecutive recipients; (3) average adjusted gross  income (AGI) for AEITC recipients; (4) average wages; (5) filing status;   (6) age; (7) gender; (8) number of qualifying children; (9) filing method;  (10) geographic location of AEITC recipients; and (11) employer size,  number of employees, and number of Forms W-2 with AEITC issued to  employees. Each of the characteristics represents an analysis and provides  additional objective information about AEITC recipients not previously  discussed. Where possible, we compared AEITC recipients to Earned  Income Tax Credit (EITC) recipients. Further analyses may provide  information to better target IRS enforcement efforts. For example, IRS’s  information on EITC associated with gender differs from our AEITC  results in table 17 on gender.
The characteristics are organized by a declining AEITC population size.  For example, table 10, “Number of Forms W-2 Received by Subpopulation,  Tax Years 2002 through 2004,” includes the valid, the invalid name, and  invalid number subpopulations, as described in the scope and  methodology (see app. II), while table 15, “Filing Status of AEITC and  EITC Recipients, Number and Percentage, Tax Years 2002 through 2004,”  includes only the valid and invalid name subpopulations. The invalid  number subpopulation was not included in the table about filing status  because that subpopulation contains only Form W-2 data and not tax  return data. Thus, information such as filing status, which comes from the  tax return, is not available.
Number of Forms W-2 with AEITC that each individual received:  Most individuals who received the AEITC only had one Form W-2  reporting its receipt (see table 10). Having more than one Form W-2 does  not necessarily indicate noncompliance because an individual may have  more than one job during the year and receive the AEITC from more than  one employer. The data did not enable us to analyze whether any of these  individuals had more than one Form W-5 in effect at one time. Presently,  IRS’s administrative procedures do not enable it to identify whether the  taxpayer has more than one Form W-5 in effect at one time.
Average amount of AEITC received by consecutive recipients:  About 98,000 individuals received the AEITC consecutively during tax  years 2002 through 2004. These 98,000 individuals received a higher  average amount of AEITC than the entire AEITC population (see fig. 6).
Adjusted gross income (AGI) for AEITC and EITC recipients: The  maximum amount of AGI a taxpayer could have in tax years 2002 through  2004 and receive the AEITC and/or EITC was $34,178, $34,692 and $35,458,  respectively. As noted in tables 11, 12, and 13, most individuals who  received the AEITC and filed a tax return reported an AGI of $1—$20,000.  Some taxpayers had an AGI above the allowable limits. However, because  an individual’s personal circumstance may have changed during the year,  for example the individual may have gotten a higher paying job, as long as  the same amount of AEITC received as shown on the Form W-2 was  reported on the tax return, AGI outside the limit for AEITC recipients is  permissible and the taxpayer is considered compliant. By reporting the  correct amount on the tax return, the AEITC would increase the tax due or  reduce any refund.
Wages for AEITC and EITC recipients: The yearly wage limits for  AEITC and EITC recipients were $34,178 for tax year 2002, $34,692 for tax  year 2003, and $35,458 for tax year 2004. The average wages for AEITC  recipients in the valid subpopulation were about $18,000, while they were  about $47,000 for the invalid name subpopulation. This compares with  about $13,000 for EITC recipients (see table 14). Some wages are outside  the allowable limits. However, because an individual’s personal  circumstance may have changed during the year, for example, the  individual may have gotten a higher paying job, as long as the same  amount of AEITC received as shown on the Form W-2 was reported on the  tax return, wages outside the limit are permissible and the taxpayer is  considered compliant. By reporting the correct amount on the tax return,  the AEITC would increase the tax due or reduce any refund.
Filing status of AEITC and EITC recipients: As shown in table 15,  about half of AEITC recipients in the valid subpopulation and most  individuals who received the EITC used the Head of Household filing  status. This compares to AEITC recipients in the invalid name  subpopulation who most frequently used the Married Filing Jointly filing  status. About 2 percent of the tax returns that reported receiving AEITC  used the Married Filing Separate filing status, which is not allowed.  However, an individual’s personal circumstance may have changed during  the year, for example the individual may have separated from their spouse.  As long as the same amount of AEITC received as shown on the Form W-2  was reported on the tax return, this situation is permissible and the  taxpayer is considered compliant. By reporting the correct amount on the  tax return, the AEITC would increase the tax due or reduce any refund.
Age of AEITC and EITC recipients: Most individuals who received the  AEITC, as well as most EITC recipients, were between the ages of 26 and  64 (see table 16). IRS officials noted that recipients whose age fell into the  ‘Over 100’ category are the result of a probable error, such as a  transcription error. Alternatively, an AEITC recipient in this category may  have used a SSN of a deceased individual.
Gender of AEITC and EITC recipients: More males than females  received the AEITC during tax years 2002 through 2004. In contrast, more  females than males received the EITC during this same period (see table  17).
Number of qualifying children for AEITC and EITC recipients:  About half of the individuals who reported receiving the AEITC had two  qualifying children. Results were similar for EITC recipients. However,  about 8 percent of this population did not report having any qualifying  children, which is not allowed (see table 18). However, an individual’s  personal circumstance may have changed during the year, for example,  the individual may have separated from their spouse or divorced. As long  as the same amount of AEITC received as shown on the Form W-2 was  reported on the tax return, the taxpayer is considered compliant. By  reporting the correct amount on the tax return, the AEITC would increase  the tax due or reduce any refund. In contrast, most individuals who  received the EITC also had two qualifying children. There is no qualifying  child requirement to receive the EITC.
Filing method of AEITC and EITC recipients: As noted in table 19,  most tax returns that showed receiving an amount of AEITC were filed  electronically, as were most tax returns which reported receipt of the  EITC. For both AEITC and EITC, about 70 percent of recipients filed  electronically for the 3 years we examined.
Geographic location of AEITC recipients in the valid  subpopulation: Of the individuals in the valid subpopulation, use of the  AEITC varied widely across the country. In all 3 tax years, Florida and  Illinois had the most AEITC recipients (see fig. 7).
Employer size, number of employers, number of forms W-2  employers issued to AEITC recipients and Total AEITC Dollars  Reported on Forms W-2: Slightly more than 50,000 employers reported  paying at least one employee AEITC in each tax years 2002 through 2004.  Most of these employers were classified by IRS as small business/self  employed and they issued more than half of all the Forms W-2 with AEITC  (see table 20).
section_title: Appendix IV: Administrative and Legislative Changes to the Advance Earned Income Tax Credit Since 1990
paragraphs: IRS has made several administrative changes to the Advance Earned  Income Tax Credit (AEITC) since the beginning of 1990 (see table 21). IRS  described these changes in responses to recommendations in our 1992  AEITC report and a 2003 Treasury Inspector General for Tax  Administration report.
There have been two laws enacted since our 1992 report that include  specific changes to the AEITC. First, the Omnibus Budget Reconciliation  Act of 1993 (OBRA ’93), did the following.  1.  Limited the amount of advance payment allowable in a taxable year to  60 percent of the maximum credit available to a taxpayer with one  qualifying child.  2.  Directed the IRS to notify taxpayers with qualifying children who  receive a refund on account of the EITC that the credit may be  available on an advance basis. The conference report accompanying  OBRA ’93 stated that after these notifications had been made for 2  taxable years, the Treasury Secretary was directed to study their effect  on utilization of the advance payment mechanism and, based on the  results of the study, the Secretary may recommend modifications to  the notification program.
Second, the U.S. Troop Readiness, Veteran’s Care, Katrina Recovery, and  Iraq Accountability Appropriations Act of 2007, which was enacted in late  May 2007, calls for a study of AEITC use. The study is to be conducted by  the Secretary of the Treasury for the Congress and is to include the  benefits, costs, risks, and barriers to workers and to businesses (with a  special emphasis on small businesses) if the AEITC included all recipients  of the EITC (i.e., individuals without qualifying children). It also asks what  steps would be necessary to implement such an inclusion.
section_title: Appendix V: Additional Analyses of Advance Earned Income Tax Credit Noncompliance
paragraphs: We identified additional areas of noncompliance for AEITC recipients  during tax years 2002 through 2004. We also examined demographic  characteristics of our noncompliant subpopulations, including the invalid  name, invalid number, and dollar limit subpopulations. Our analyses  revealed the following: (1) some consecutive AEITC recipients had an  invalid SSN, (2) most consecutive AEITC recipients filed a tax return, but  did not report the correct AEITC amount on the tax return, (3) AEITC  recipients with an invalid SSN received little money, (4) most AEITC  recipients with an invalid SSN received one to two Forms W-2, (5) AEITC  recipients in the invalid subpopulations lived in various geographic  locations, and (6) AEITC was paid in excess of yearly maximum limits. As  with the data in Appendix III, further analyses of this data may provide  information on noncompliance characteristics potentially useful for IRS  enforcement efforts.
Each of the tables provides additional information about AEITC recipients  not previously discussed. Where possible, we compared AEITC recipients  to EITC recipients. The characteristics are organized by a declining AEITC  population size, similar to the organization in appendix III. Most analyses  include the invalid name and invalid number subpopulations. The  subpopulations are described in the scope and methodology section (see  app. II).
Some consecutive AEITC recipients had an invalid SSN: About  98,000 individuals received the AEITC consecutively in each of the 3 years,  tax years 2002 through 2004, and received an average of about $56 million.  About a quarter of these individuals had an invalid SSN and received an  average of approximately $16 million in AEITC. Additionally, nearly 15  percent of consecutive users had an invalid SSN and did not file a federal  tax return, receiving an average of about $9 million in AEITC (see table  22).
Most consecutive AEITC recipients filed a tax return, but did not  report the correct AEITC amount on the tax return: About 98,000  individuals received the AEITC consecutively in each of the 3 tax years,  2002 through 2004. More than half of these individuals filed a tax return. Of  those who filed, about half reported the same AEITC amount on the tax  return as shown on the Form W-2 (i.e., matched). Of the mismatches, the  majority did not report receipt of the AEITC (see table 23).
AEITC recipients with an invalid Social Security number (SSN)  received little money: Most AEITC recipients who had a Form(s) W-2  with an invalid SSN obtained $100 or less of AEITC (see table 24). These  data are consistent with the overall AEITC population, as previously  noted, where about half of all recipients received less than $100 and 80  percent received $500 or less for the year.
Most AEITC recipients with an invalid SSN received 1 to 2 Forms  W-2: Most recipients who had an invalid SSN received 1 to 2 Forms W-2  reporting AEITC.  For example, in tax year 2002, 6,223 individuals received  two Forms W-2 that reported AEITC. These resulted in a total of 12,466  Forms W-2 equaling $3,261,327 in AEITC, with an average of $262 in  AEITC per Form W-2 (see tables 25, 26, and 27).
AEITC recipients in the invalid subpopulations lived in various  geographic locations: Use of the AEITC varied widely across the country  for individuals in the invalid number and invalid name subpopulations. For  the invalid name subpopulation, in all 3 tax years, California and Illinois  had the most Forms W-2 reporting AEITC and for the invalid number  subpopulation, in all 3 tax years, Florida and Illinois had the most (see  figs. 8 and 9).
AEITC was paid in excess of yearly maximum limits: A total of  almost 12,000 Forms W-2, reporting about $64 million, showed AEITC paid  above the yearly maximum between tax years 2002 through 2004 (see figs.  10 and 11). Specifically, in tax year 2002 there were 6,408 Forms W-2 above  the yearly maximum reporting almost $44 million; 2,690 in tax year 2003,  reporting over $7 million; and 2,768 in tax year 2004, reporting almost $13  million. As noted in figure 10, most Forms W-2 above the yearly maximum  were between $1 above the limit and $5,000. An individual receiving the  AEITC was eligible to obtain a maximum yearly amount of $1,503 in tax  year 2002, $1,528 in tax year 2003, and $1,563 in tax year 2004.
section_title: Appendix VI: Comments from the Internal Revenue Service
section_title: Appendix VII: GAO Contacts and Staff Acknowledgments
subsections: section_title: Acknowledgments
paragraphs: In addition to those named above, Blake Ainsworth, Frances Cook, James  Cook, Rebecca Gambler, Evan Gilman, George Guttman, Donna Miller,  Cheryl Peterson, Michael Rose, Steve Sebastian, Daniel Schwimer, Richard  Stana, James Ungvarsky, Michael Volpe, and Paul Wright made key  contributions to this report.