Earned Income Credit: Qualifying Child Certification Test Appears Justified, but Evaluation Plan Is Incomplete
Published: 2003-09-30T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Earned Income Credit (EIC), a tax credit available to the working poor, has experienced high rates of noncompliance. Unlike many benefit programs, EIC recipients generally receive payments without advance, formal determinations of eligibility; the Internal Revenue Service (IRS) checks some taxpayers' eligibility later. IRS estimated that tax year 1999 EIC overclaim rates, the most recent data available, to be between 27 and 32 percent of dollars claimed or between $8.5 billion and $9.9 billion. To address overclaims, IRS plans to test a new certification program. Because IRS's plans have garnered much attention, Congress asked us to (1) describe the design and basis for the EIC qualifying child certification program, (2) describe the current status of the program, including significant changes, and (3) assess whether the program is adequately developed to prevent unreasonable burden on EIC taxpayers and improve compliance so that the test should proceed.
section_title: What GAO Found
paragraphs: The Assistant Treasury Secretary and IRS Commissioner convened a task force to identify ways of reducing EIC overclaims while minimizing taxpayer burden and maintaining the EIC's relatively high participation rate. In August 2002, the Secretary approved a recommendation to certify taxpayers' eligibility to claim EIC qualifying children. The proposal is based on analyses of the leading sources of EIC errors, thus focusing attention and burden on the subset of taxpayers most likely to make those errors. Since August 2002, IRS has made key changes to the certification program, including concentrating on residency certification and postponing relationship certification, delaying program implementation until later this year, and reducing the test sample from 45,000 to 25,000. Despite the changes, the process for selecting taxpayers, what taxpayers will receive from IRS, what taxpayers are required to provide, and the program's goals remain fundamentally the same as originally planned. In addition, IRS has emphasized that program expansions, if any, will depend on the results of this year's test. The process would involve three key stages. These changes, including the most recent, help achieve a better balance between preventing unreasonable taxpayer burden and addressing the EIC's high overclaim rate and support IRS's plans to test the certification program. However, IRS's plan for evaluating the test is incomplete, presenting only some information on how IRS would evaluate whether certification would reduce the EIC overclaim rate, minimize burden, and maintain a relatively high participation rate. The plan proposes potential options for identifying how and when certain critical data will be obtained, but does not provide further details on when decisions will be made or on the specific data that will be collected. Officials have developed preliminary drafts identifying data to be obtained and have begun considering how to use contractors to gather the data. Because the data relate to taxpayers' actions that will occur next spring, IRS appears to have some time to finalize its evaluation plan.

section_title: Letter
paragraphs: The Earned Income Credit (EIC), a tax credit available to the working poor,  has generally been considered a successful antipoverty program by  researchers. In recent years, the Internal Revenue Service (IRS) has paid  about $30 billion annually to about 20 million EIC recipients. However, the  EIC program has long experienced high rates of noncompliance. For tax  year 1999, IRS estimated the EIC overclaim rates ranged between 27 and  32 percent of dollars claimed or between $8.5 billion and $9.9 billion.  Unlike many benefit programs, EIC recipients generally receive payments  without a prior, complete review of their eligibility; IRS checks some  aspects of taxpayers’ eligibility before and after the credit is granted.
To help combat the high rates of noncompliance, IRS plans to test a new  program, beginning in December 2003. Referred to as the qualifying child  certification program, some taxpayers will be asked to verify EIC  “residency” requirements for their qualifying children before getting that  portion of their refund or reduction in tax liability.  IRS plans to test the EIC  program with 25,000 taxpayers whose residency cannot be confirmed  through other means. Future plans for the program largely depend upon  the results of this test.
Because IRS’s plans surrounding the program have garnered much  attention, you asked us to respond to questions about the qualifying child  certification program. These questions cover various topics, such as the  status of the program, understandability of letters and forms going to  taxpayers, certification requirements and taxpayers’ ability to comply,  taxpayer burden, impact on compliance rates, impact of recent legislative  changes, and data from other federal or state benefit programs. We grouped  these questions into three objectives: (1) describe the design and basis for  the EIC qualifying child certification program as proposed by the EIC task  force, (2) describe the current status of the program, including significant  changes since program approval, and (3) assess whether the program is  adequately developed to (a) prevent unreasonable burdens on EIC  taxpayers and (b) improve compliance so that the test should proceed.  In  addition, you asked us to provide readily available information on the    (1) significant noncompliance rates other than for the EIC and (2)  overclaim rates and administrative costs of comparable benefit programs  administered by states or the federal government and any verification  process used by these programs. This information is presented in  appendixes I and II, respectively.
This report is based primarily on our previous work and analysis of IRS and  Department of the Treasury documents and reports, new letters and forms  that will be sent to taxpayers, and interviews with senior officials at IRS  and Treasury. We did not verify the accuracy of reports or data obtained.  Rather, we reviewed the steps IRS officials had taken to implement the  program and determined, to the extent possible, how they assured  themselves that the program had been adequately developed to prevent  unreasonable burden and improve compliance. We did not determine the  adequacy of various other preparations for the qualifying child test, such as  staffing and training of staff. Appendix III provides more detail on the  scope and methodology used in conducting our work.
subsections: section_title: Background
paragraphs: Congress enacted the EIC in 1975 with the goal of offsetting the Social  Security taxes paid by the working poor and creating a greater work  incentive for low-income taxpayers. According to data cited in the task  force report, an estimated 4.3 million individuals were lifted out of poverty  in 1998 by the EIC, including 2.3 million children.
The EIC is a refundable tax credit, meaning that qualifying working  taxpayers may receive a refund greater than the amount of income tax paid  during the year. Taxpayers can qualify for the credit in one of two ways:  with a “qualifying child” or by “income only,” if they do not have a  qualifying child. For example, for tax year 2002, the amount of EIC that  could be claimed with a qualifying child or children ranged from $0 to  $4,140. EIC payments have a phase-in range in which higher incomes yield  higher EIC amounts, a plateau phase in which EIC amounts remain the  same even as income rises, and a phase-out range in which higher incomes  yield lower EIC payments or tax liability.
EIC requirements for tax year 2002 include rules for everyone, additional  rules for taxpayers with qualifying children, and additional rules for  taxpayers without qualifying children, as shown in table 1.
IRS has periodically measured EIC compliance for overclaims and  underclaims. The most current data available, for tax year 1999, show EIC  overclaim rates estimated to be between 27 and 32 percent of dollars  claimed or between $8.5 billion and $9.9 billion. IRS has limited data on  underclaims, which for tax year 1999 were estimated to be between   $710 million and $765 million. IRS has tried to reduce noncompliance  through various means, including education and outreach to taxpayers and  tax return preparers. In addition, Congress has enacted legislation aimed at  resolving some concerns with EIC rules. Because a new analysis of EIC  compliance using 2001 tax return information is not expected to be  complete until late in 2004, IRS does not know whether compliance has  significantly changed since 1999, but officials do not think it has improved substantially. Because of the persistently high rates of noncompliance, we  have identified the EIC program as a high-risk area for IRS since 1995.
Currently, taxpayers claim the EIC by filing an individual income tax return  (e.g., a Form 1040 or 1040A) and including a Schedule EIC—a procedure  similar for claiming other tax credits.  Unlike with other benefit programs  such as Supplemental Security Income, however, EIC taxpayers are not  required to be found qualified before claiming the credit or file any other  documents with their return to establish eligibility. Instead, IRS uses four  primary means to evaluate EIC eligibility and check for noncompliance  after the return is filed and checks some aspects of taxpayers’ eligibility  before and after the credit is granted:  (1) the math error program, (2)  correspondence and face-to-face examinations (also called audits), (3) the  document matching program, and (4) criminal investigations. Some of  these means, such as the math error program, check all EIC returns, but  only for limited aspects of eligibility. Other means, such as examinations,  only check a small subset of EIC returns, but the review is more expansive.  In general, IRS subjects all returns to its math error program and takes  corrective action on errors found. Depending on the resources IRS has  available, IRS works only a small portion of cases identified as potentially  meriting follow-up under its examination, document matching, and  criminal investigations efforts.
While processing all tax returns, IRS uses its automated math error  program to identify and correct the simpler errors found in claiming the  EIC. For example, the math error program can identify invalid Social  Security numbers and taxpayers who fail to follow recertification  requirements. As a result, some inappropriate EIC claims are stopped  before refunds are issued. During fiscal year 2001, IRS stopped more than  371,000 incorrect EIC claims using its math error authority. After  identifying errors, IRS corrects them so the tax return can be processed  and sends a computerized notice to the taxpayer identifying the error and  stating that IRS disallowed or reduced the EIC claim. The notice tells  taxpayers that if they can correct the error, the EIC claim will be allowed  and any refund related to the EIC claim will be issued.
Two types of examinations—-correspondence and face-to-face—are used  when EIC noncompliance is suspected, in most cases before refunds are  issued. IRS uses various systematic means to “score” the likelihood of  noncompliance on any return and uses experienced staff to manually  identify the specific items on returns for examination. Most EIC  examinations occur shortly after a return is filed, largely because of the  difficulty in recovering refunds. IRS stops refunds on these returns until  examinations are completed. This contrasts with IRS’s normal examination  practice of performing examinations many months after tax returns have  been processed and any refunds paid. The EIC examinations usually rely  on correspondence with taxpayers rather than face-to-face contacts. IRS  completed about 368,000 EIC related correspondence exams during fiscal  year 2002. IRS tends to use face-to-face meetings with taxpayers to  examine tax returns with EIC claims on a very limited basis and primarily  when examinations are initiated for other reasons. As part of either type of  examination, however, IRS would describe the potential noncompliance in  a computerized notice to taxpayers claiming the EIC. IRS requests  documentation, such as a school record or birth certificate, to establish  EIC requirements. Depending on whether IRS officials accept or reject the  support, they may make changes to the return and refund related to the EIC  claim. If taxpayers disagree with IRS’s decisions, they have the right to  appeal administratively and/or through the courts.
IRS also uses its document matching programs to identify potentially  misreported income on tax returns claiming the EIC. By comparing the tax  return to wage and income statements provided by third parties such as  employers and financial institutions, the document-matching program  identifies whether a taxpayer appears to have misreported income. Given  the phase-in and phase-out ranges of the EIC, some taxpayers may claim  too much EIC by overreporting or underreporting their income. This  program notifies such taxpayers months after returns are filed and refunds  are issued. Similar to audits, a notice is issued telling a taxpayer that an  error appears to have been made, that he or she may disagree and provide  any support for income reported, and that he or she may appeal IRS’s  decision about additional taxes owed. Unlike audits, the program is highly  automated and is designed to require less contact with taxpayers by IRS  staff.
IRS also uses criminal investigations to stop the payment of false refunds,  identify refund scams/schemes, and prosecute perpetrators, including  those with fraudulent EIC claims. For EIC, IRS uses a specific computer  program that looks for questionable refund claims and for return preparers  known to have prepared questionable returns. IRS also has teams that scan  returns and receive referrals from other parts of IRS and informants. IRS  stops many returns as they are being processed so that criminal  investigators can review the claims before the refund is paid or after the  return has been processed.
section_title: Task Force Considered Much Information Related to EIC Compliance before Recommending Qualifying Child Certification Program
paragraphs: When IRS’s study of EIC compliance rates for 1999 was released, the  Assistant  Secretary of the Treasury and IRS Commissioner convened a  task force in February 2002 to find ways of reducing EIC overclaims while  minimizing the burden to taxpayers and maintaining the EIC’s relatively  high participation rate. The task force considered whether changes in  statutes recently enacted by Congress or proposed by Treasury may have  lessened the need for new EIC compliance initiatives and concluded that,  while statutory changes addressed some sources of noncompliance, they  likely would not reduce other leading sources of noncompliance. The task  force also considered a range of new methods, including partnering with  other federal or state agencies or programs and developing a new database  to verify EIC eligibility before issuing tax refunds, but decided that these  options were not viable. Ultimately, the task force recommended the  qualifying child certification program. The task force reviewed IRS’s EIC  compliance study results and other data, as well as other studies, to  identify the sources and develop new methods of addressing  noncompliance.
subsections: section_title: Task Force Convened to Address Long-Standing Compliance Problem
paragraphs: The joint Treasury and IRS task force addressed a long-standing problem of  high EIC overclaim rates. Although the release of IRS’s 1999 compliance  study precipitated the formation of the EIC task force in February 2002, the  study results were generally consistent with high overclaim rates reported  in prior IRS studies. While some stakeholders view the 1999 study as having  some methodological weaknesses, it showed that of the approximately 20  million taxpayers that claimed the EIC in 1999, 46 to 50 percent of their tax  returns had errors that led to claiming too much of the credit (IRS often  refers to this as the error rate). IRS also estimated that the total dollars  overclaimed on those returns represented between 27 and 32 percent of  total EIC dollars claimed in 1999, or between $8.5 billion and $9.9 billion.
IRS also has some data on underclaims—instances where taxpayers  claimed less than they were entitled to receive. For tax year 1999,  underclaims were estimated to be between $710 million and $765 million.
IRS has conducted EIC compliance studies for several years and the  overclaim rate, which is the percentage of total dollars paid out in error,  was estimated to be about 24 percent in tax year 1994. According to IRS  officials, because different methodologies were used in the subsequent  studies, changes in estimated overclaims found in other studies do not  support conclusions about trends in the overclaim rate over time. However,  IRS officials also acknowledged the overclaim rate has not improved  significantly. Overclaim rates for tax years 1997 and 1999 are shown in table  2.  The information in table 2 does not reflect the current compliance  situation; for example, it does not reflect the presumably positive impact of  new legislation that has taken effect since 1999 aimed at improving  compliance.
Although IRS’s studies have shown high EIC overclaim rates for many  years, other studies had shown that EIC’s participation rate was fairly high.  For example, in 2001 we reported that an estimated three of every four  eligible participants received the EIC in tax year 1999. For taxpayers with  one or two qualifying children, we estimated that participation rates  exceeded 90 percent.  Individuals with no children, who receive a much  smaller credit than taxpayers with qualifying children, had a much lower  participation rate that we estimated to be about 45 percent. Although at the  time we reported that available data did not enable us to determine the  reasons for these differences, IRS officials attributed these differences, in  part, to the lower EIC amounts allowed for individuals and because the  program did not include individuals without children when it first began.
section_title: Task Force Reviewed Recent Legislative Changes Likely to Improve Compliance
paragraphs: The EIC task force reviewed whether recent statutory changes have the  potential to reduce the major sources of EIC noncompliance, either by  changing the rules or providing IRS new enforcement options. Because the  study of tax year 1999 compliance was the most recent available, the task  force lacked data on the effect of the recent changes and relied on other  analyses that showed whether the changes would affect compliance. Of the  recent changes, the task force estimated that one change, to the Adjusted Gross Income (AGI) tiebreaker rule, would likely reduce noncompliance.   The task force judged that the other legislative changes, including those  proposed by Treasury, while potentially helping reduce noncompliance  from other sources, would not be enough to reduce noncompliance  without further IRS efforts.
Three key pieces of legislation, which have been recently enacted or taken  effect, were at least partially aimed at improving EIC compliance, as shown  in table 3. They may eventually help reduce noncompliance after taxpayers  and tax preparers become familiar with the new laws. The statutory  changes were to serve several purposes, including improving compliance  and simplifying tax laws associated with the EIC.
A Treasury study showed that the change in the AGI tiebreaker rule  effective for tax years after December 31, 2001, would likely have  eliminated about $1.4 billion of the nearly $2 billion in tax year 1999 EIC  overclaims that were due to tiebreaker errors. Accordingly, the task force  decided that this source of EIC overclaims did not need to be further  addressed by a new compliance initiative.
Although officials recognized the benefits of these recent legislative  changes to help improve EIC compliance, they concluded that additional  initiatives were still needed. For example, officials recognized the value of  IRS being able to use math error authority to deny EIC claims on and after  January 1, 2004, when the Department of Health and Human Services’  Federal Case Registry (FCR) indicates that the taxpayer is the noncustodial  parent of the qualifying child. However, officials told us that this authority  was limited and not applicable to a significant number of taxpayers whose  compliance may be problematic. IRS has a study in process to determine  the effectiveness of using FCR data to deny EIC claims using its math  authority. The study was scheduled for completion by July 30, 2003, but as  of August 20, 2003, was not yet completed.
section_title: Task Force Considered Three Alternatives to Improve Qualifying Child Compliance
paragraphs: The EIC task force considered three key options to verify taxpayers’  qualifying children: (1) partnering with other federal or state agencies or  government programs to verify EIC taxpayers’ eligibility, (2) creating a  federal database that would automatically match and detect questionable  or erroneous EIC claims, and (3) certifying taxpayers’ eligibility for certain  EIC criteria.  Ultimately, in August 2002, the Secretary of the Treasury  approved the qualifying child certification program, which at the time was  to include providing proof of eligibility in advance of the filing season  (July–December), and was referred to as “precertification.”
The first two options were expected to impose little or no documentation  requirements on taxpayers. The task force was trying to determine for both  options whether sufficient information was already available from others,  or that little additional information would need to be collected by others, to  verify a taxpayer’s qualifying children. However, the task force found that  there was little overlap between the EIC population and verification  criteria used to administer other federal or state programs. In addition,  although some databases existed, the task force found that they could not  be used to effectively verify EIC eligibility, largely for the same reason.  Consequently, the task force judged that these options were not likely to be  useful in addressing EIC compliance problems. Similarly, the task force  also found that if a federal database were created to facilitate EIC  verification, IRS would have to gather the bulk of the information itself,  thus imposing a burden on taxpayers, which would also be costly and time- consuming for IRS. The third option, which the task force selected,  required taxpayers to demonstrate EIC eligibility for certain criteria,  namely residency and relationship tests for qualifying children, prior to  receiving the credit.
The relative cost of the options the task force considered did not drive the  decision to select the qualifying child program because the other two  alternatives were not considered viable. The task force did compare IRS’s  EIC administrative costs to those of other federal benefit programs and  found them to be much smaller. IRS has had a special appropriation for EIC  compliance initiatives since 1998—and has received about $875 million  total through fiscal year 2003. It requested a total of about $250 million in  fiscal year 2004, which included $100 million for the EIC compliance  initiatives, including the qualifying child program, and about $150 million  for the special appropriation. IRS estimated that this $250 million total  was about 0.8 percent of the total annual EIC benefits distributed, and  therefore much smaller than the 9 to 13 percent administrative costs the  task force had found for other benefit programs. See appendix II for more  information we obtained on administrative costs for other benefit  programs.
section_title: Task Force Reviewed Studies and Data to Design Initiatives Focused on Known Sources of Compliance Problems
paragraphs: The EIC task force reviewed IRS studies, other IRS data, and studies by  other parties to better understand the sources of EIC noncompliance and  devise new initiatives to address those known sources. In reviewing IRS  studies and data, the task force found that the three leading sources of EIC  errors resulting in overclaims in 1999 were (1) claiming nonqualifying  children incorrectly, accounting for about $3 billion, (2) using the wrong  filing status, accounting for about $2 billion, and (3) misreporting income,  also accounting for about $2 billion.  Three administrative proposals  resulted, involving (1) qualifying child certification, (2) improper filing  status, and (3) income misreporting. In 1999, another leading source of  EIC overclaims involved taxpayers with lower modified adjusted gross  income claiming a child when another person with a higher income should  have done so.  The task force did not propose an initiative dealing with  these errors, primarily because the “AGI tiebreaker” legislation was  specifically enacted to decrease this source of noncompliance, as  previously discussed.
To deal with the error attributable to claiming children who are not EIC  qualifying children, the task force proposed a qualifying child certification  program.  Based on analyses of past compliance data, IRS found that  taxpayers who overclaimed the EIC, most frequently claimed children who  did not meet the residency or relationship criteria. As a result, the task  force proposed the qualifying child program that was to include an annual  residency certification and a one-time relationship certification.
Under this program, during the period from July through December,  taxpayers would have been asked to document that the children they  intend to claim under the EIC, meet the EIC relationship and residency  criteria. The task force proposed targeting the program to those taxpayers  with qualifying children for whom IRS could not establish residency or  relationship through other available means and it proposed that this  concept be tested on a sample of EIC taxpayers for the tax year 2003. The  task force envisioned that ultimately all EIC claimants whose eligibility  could not be verified through available means would be asked to provide  additional eligibility documentation prior to the filing season. Taxpayers  who successfully certified qualifying children’s eligibility in advance of the  filing season would have their claims processed and paid expeditiously  during the filing season, absent any other problems with their tax return or  EIC claim.  Having taxpayers certify between July and December was also  intended to allow IRS to process the taxpayers’ documents outside of the  filing season when IRS processing systems are in highest demand.  Taxpayers who did not respond and/or were unable to document their  eligibility during the certification period, but then claimed the EIC when  they submitted their tax returns, would have the EIC portion of their tax  refund frozen. Then they would be required to provide the same  documentation during or after the filing season as they were asked to  provide during the certification period. When and if they document their  eligibility, the EIC portion of their refunds would be released.
subsections: section_title: Process for Identifying Taxpayers When IRS Planned to Certify for Relationship
paragraphs: According IRS officials, as the task force neared its end and before the  Secretary of the Treasury approved the program, IRS developed a means  for using existing data to determine whether each taxpayer likely would  meet the relationship or residency test for children they had claimed for  EIC for tax year 2002. For relationship, IRS developed a plan to match  taxpayers to several databases that show the parents of children. For  instance, one database IRS planned to use was the Social Security  Administration’s database (which IRS refers to as KIDLINK) that ties  parent’s and children’s Social Security numbers for children born after 1998  in U.S. hospitals. For tax year 2003, IRS had planned to match 1.6 million,  or 10 percent of the approximately 16 million EIC taxpayers with a  qualifying child, to the databases. Under this scenario, any taxpayer who  was not shown to be the parent of a qualifying child claimed for tax year  2002 would then be part of the population from which IRS would randomly  select taxpayers to test for relationship.
section_title: Process for Identifying Taxpayers to Certify for Residency
paragraphs: IRS considered the work of the task force in developing a comparable  means for using available data to identify those who have met the residency  criterion.  The task force had analyzed data from the 1999 compliance  study and information in other reports. It found that residency errors  related to qualifying children were often correlated with the taxpayer’s  relationship to the child and the taxpayer’s filing status and gender. The  analysis showed that, overall, parents who filed married filing jointly were  the most compliant when compared to taxpayers filing single or head of  household in claiming a qualifying child who meets the residency test.   Married filing jointly parents had the fewest qualifying child residency  errors—1.5 percent—compared to any other combination of taxpayers by  relationship to the child, gender, or tax filing status.  Among taxpayers who  file single or head of household, mothers were the most compliant (see  figure 1).
The task force also found other reports that reinforced the results of its  analysis. Specifically, an independent study of low-income households in  three urban areas estimated that children resided with biological mothers  90 percent of the time. Another study estimated that 89 percent of children  in low-income households lived with both parents or their mother.
IRS used this information to propose a process for identifying taxpayers to  include in the population that would be subject to the residency  certification requirement. IRS proposed that the 1.6 million taxpayers, or   10 percent of the 16 million taxpayers with a qualifying child, would be  matched to the FCR database.  IRS officials considered the FCR to be the  most useful database for identifying those meeting the residency  requirements.  This database compiles court and other records that  indicate who is the custodian for a child (which could be a parent or  nonparent). IRS assumes that children live with the custodian of record.  According to IRS, the FCR database contains custodial information for  about 40 percent of the EIC population.  If a taxpayer matched as the  custodian of the child claimed for the EIC for 2002, the taxpayer would not be among those needing to certify.  When the FCR database showed  someone was the custodian of a child other than the EIC taxpayer who had  claimed that child for the EIC in 2002, those taxpayers would be among the  group from which the residency certification sample would be drawn.
When the FCR contains no information about the child a taxpayer had  claimed for EIC in 2002, the IRS would attempt to establish the relationship  of taxpayers to qualifying children by comparing information in several  databases. Those taxpayers IRS could identify from databases as the child’s  mother would be excluded from the sample, if they filed married filing  jointly, single, or as head of household.  Mothers would be excluded on the  basis of the task force analyses showing mothers to be among the most  compliant on the residency criterion.  Also excluded from the sample  would be fathers who filed as married filing jointly.  Otherwise, all males  who were shown to be a child’s father filing single or head of household  would be included in the group from which the certification sample would  be drawn because of the data showing a high level of noncompliance on the  residency criterion for these taxpayers. Finally, all nonparents who are not  shown in the FCR to be the custodian would go into the group from which  taxpayers would be selected for residency certification, also due to  information showing nonparents to be among the less compliant taxpayers  on the residency criterion. The selection processes for relationship and  residency would have, therefore, yielded a group of taxpayers that would  include some needing to certify for relationship only, some for residency  only, and some to certify for both.
section_title: IRS Has Made Key Changes to Its Initial Qualifying Child Certification Program and More May Occur
paragraphs: Since adopting the EIC task force recommendations in August 2002, IRS  has made key changes to the qualifying child certification program in  response to input received and additional analyses done.  Some of these  changes include (1) postponing relationship certification for an  undetermined period of time, (2) delaying program implementation, and   (3) reducing the test sample from 45,000 to 25,000.  However, these changes  create additional challenges for IRS and taxpayers.  Despite these  challenges, the process for selecting taxpayers, what taxpayers will receive  from IRS, and what taxpayers will be required to provide remains basically  the same as originally planned. According to officials, the same factors  were considered when setting the new sample size, which is still designed  to allow IRS to achieve the same goals as the original sample size, albeit to  a lesser extent.
In addition, IRS has emphasized that program expansions, if any, will  depend on the results of this year’s test.  Concerns we identified in our  report on recertification were considered and taken into account by IRS  in designing the new qualifying child certification program.
subsections: section_title: IRS Broadly Adopted Task Force Recommendations in Its Initial Design of the Qualifying Child Certification Program
paragraphs: IRS took the broad charge from the EIC task force and designed the  qualifying child certification program. Its focus was to decrease the EIC  overclaim rate while striving to maintain the high rate of participation and  minimize taxpayer burden. Initially, IRS decided that the certification  program would involve  testing of 45,000 taxpayers for both relationship and residency  beginning in July 2003, and  immediately expanding the certification program for relationship to 2  million taxpayers in 2005 and to both relationship and residency in  substantial numbers in future years.
However, as IRS obtained input on the program, it modified these plans.
section_title: Certification for Residency Only Is to Begin in December 2003 for 25,000 Taxpayers
paragraphs: Since initially formulating plans for the qualifying child certification, IRS  has made multiple changes to the program.  First, IRS postponed  relationship certification for an undetermined period for a number of  reasons. IRS had developed a draft form for certifying relationships and  obtained input on the form from external and internal stakeholders. Some  stakeholders raised concerns about whether taxpayers would be able to  provide some of the types of documentation IRS planned to request, such  as marriage certificates, within the time envisioned. IRS officials said that  testing the relationship certification this year was postponed, in part,  because these concerns were unresolved. The officials also noted that  Treasury studies have shown relationship requirements to be a lesser  compliance issue than residency, and taxpayers that were found to be  noncompliant with relationship requirements were also often  noncompliant due to residency errors. Since both residency and  relationship requirements have to be met, if taxpayers fail certification on  residency there would be no need to test on relationship. Consequently,  officials gave a higher priority for testing residency certification.
Second, IRS has changed the start date of the test twice.  Originally, IRS  planned to start the test in July 2003, but postponed implementation until  mid-August.  As we were finalizing this report, IRS announced in August  that it now plans to begin the test in December 2003, in conjunction with  the 2004 tax filing season. (Appendix IV shows key milestones from 2002  through 2005.) According to IRS officials and documents, implementation  was postponed from July to August to allow time to conduct focus group  testing, request and obtain public comments during a 30-day period, and  make changes to the program as a result of those efforts. Thereafter, IRS  postponed implementation a second time from August to December to  ensure (1) taxpayers have better access to tax practitioners since many  only operate during the filing season and (2) more time for outreach and  education.
However, as a result of the delays, taxpayers will be providing proof of  residency documentation during the filing season and not “precertifying”  before the filing season as originally envisioned. This change is important  and creates additional challenges for both IRS and taxpayers, as follows:   Taxpayers will no longer have the opportunity to provide proof of  qualifying child residency, correspond with IRS in advance of the filing  season, and resolve any potential issues before filing their tax returns.   Because all correspondence will take place during the filing season,  selected taxpayers could experience a delay in receiving the EIC portion  of any refund, if the EIC portion is frozen because of any problems until  certification is successfully completed.
IRS will no longer be able to spread out its workload and processing  may be slower since certification will occur during the filing season--- IRS’s busiest time of year.
IRS will not have the opportunity to assess taxpayers’ ease or difficulty  in obtaining required documentation in advance of the filing season and  whether taxpayers would do so.  This is important because taxpayers  may be given the opportunity to certify in advance of the filing season in  future years.
Third, IRS reduced the number of taxpayers included in the test from  45,000 to 25,000, in part, in response to comments received during the 30- day public period.  According to IRS officials, despite reducing the number  of taxpayers included in the test, the sample size should still allow IRS to  make statistically valid measurements of results in addition to helping IRS  meet its desired goals of protecting revenue and testing the process for  conducting the certification program.  In addition, the smaller sample  should help mitigate the challenge related to processing the certification  forms during the filing season.
section_title: Process for Selecting Taxpayers, What They Will Receive, and What They Will Provide to IRS Remains Basically the Same
paragraphs: Despite these changes, how IRS selected taxpayers for the test, what  taxpayers will receive from IRS, and what taxpayers will be asked to  provide as proof of residency for qualifying children will remain  fundamentally the same.  IRS’s process for selecting the taxpayers for the  test is shown in figure 2.  Using this process, IRS selected 25,000  taxpayers in August.  The 25,000 represents about 0.16 percent of the  approximately 16 million EIC claimants with a qualifying child in tax year  2002 and about 0.13 percent of the approximately 20 million EIC recipients  overall.
According to agency officials, IRS will now send the 25,000 taxpayers forms  and instructions about the program in December instead of this summer.   IRS plans to send Notice 84-A, a letter informing them about the new  program; Form 8836, “Qualifying Children Residency Statement;”  Publication 3211M, “Earned Income Tax Credit Question and Answers;”  and Publication 4134, “Free/Nominal Cost Assistance Available for Low  Income Taxpayers.” However, officials are changing these documents  based on the public comments received.   Appendix V has the most current  copies of these documents.
Once taxpayers receive this information from IRS, they would obtain  documentation to prove the qualifying child’s residency and send it back to  IRS. IRS examiners would review the documentation and send a letter back  to the taxpayer either accepting or rejecting the claim, as shown in figure 3.
IRS currently envisions that the 25,000 taxpayers selected for certification  will be required to provide proof that the qualifying child meets residency  requirements before getting the EIC portion of their refund. IRS officials  say that taxpayers who are able to establish eligibility when filing their tax  return should receive their refunds more expeditiously than those who do  not.  Taxpayers selected for certification but who are not able to provide  the necessary documentation will be treated essentially the same as  taxpayers undergoing a correspondence audit. The EIC portion of their  refund—if they are to get one—will be frozen until proof of eligibility is  established.
section_title: Same Factors Considered When Setting Smaller Sample Size
paragraphs: According to IRS’s draft evaluation plan for the certification test and our  discussions with officials, three factors were considered in setting the  original sample size of 45,000:  (1) show that certification would “protect  revenue,” (2) determine whether the test will succeed, and (3) test its  processes and systems.  According to IRS officials, the smaller sample size  of 25,000 is designed to allow IRS to achieve the same goals as the original  sample size, albeit to a lesser extent.
One factor considered by IRS for the certification test was to stop as large  an amount of EIC overclaims due to ineligible qualifying children as  possible during the 2003 tax year. To determine how many taxpayers to  include in the certification test to achieve this goal, officials said they  determined the maximum number of staff that could be assigned to and  adequately supported by the planned central unit in Kansas City that would  be responsible for the certification program. Based on the maximum  number of staff that could be assigned and assumptions about how many  cases staff could handle, IRS calculated that 45,000 taxpayers could be  included in the test. IRS estimated that $114.5 million in protected revenues  could be realized from including 45,000 taxpayers in the test.  Based on the  revised sample size of 25,000, IRS now estimates that $63.6 million in  protected revenues could be realized.
A second factor considered was to have a large enough sample to support  analyses of whether the test succeeds. For instance, IRS is interested in  how many taxpayers provide the information needed for IRS to determine  qualifying child eligibility, whether taxpayers in the sample population who  are actually qualified to claim the EIC do not do so with their 2003 tax  return and why, and whether taxpayers found the certification process  burdensome. IRS’s draft plan for evaluating the certification test notes that  the original 45,000 sample size was much larger than needed to obtain  statistically valid measures of test results.  The draft plan indicated that a  sample size of about 3,600 taxpayers, which would have provided an  estimate at 95 percent confidence levels plus or minus 5 percent, was the  number of taxpayers needed for IRS to determine qualifying child  eligibility.  According to the draft plan, the 45,000 sample size would allow  very precise estimates for the population as a whole and should provide  statistically valid information about sub-sets of claimants.  Despite the  reduction to 25,000, IRS officials still believe that this sample size will allow  for precise estimates for the universe as a whole and smaller subsets as  well.
Finally, a third factor in selecting both the 45,000 and 25,000 sample sizes  was to have a large enough sample to test the processes and systems that  would be required if IRS were to expand certification in the coming year.  IRS had been preparing to work on approximately 25,000 certification  cases during the filing season under its original plan for 45,000 taxpayers.   It based the 25,000 on worst case assumptions about how many of the  45,000 would not opt to submit proof of eligibility in advance of the filing  season and, instead, would have submitted their documentation during the  filing season.  In addition, for this goal, the draft plan preceded IRS’s  current thinking that the certification program likely will not be expanded  as rapidly next year, if expanded at all. However, according to IRS officials,  based on the number of cases IRS estimates can be worked on and what it  plans to achieve under this goal, the 25,000 sample size is appropriate to  help test the systems and processes.
section_title: Future Expansion of Certification Program Depends on Test Results
paragraphs: Although IRS has consistently referred to the certification effort as a test,  officials recently have stressed this point. For example, officials have  recently referred to the efforts for this year as a “pilot or proof of concept.”   Furthermore, as a result of the most recent changes, the program will no  longer take place in advance of  the filing season, but instead, during the  filing season. IRS officials told us that it is unlikely that the certification  program will be expanded to cover 2 million claimants in the summer of  2004, as originally anticipated.  Instead, IRS officials plan to assess the  program’s overall effectiveness and make any necessary modifications  before expanding it to additional EIC claimants in the future. Thus,  particularly in light of IRS’s most recent announcement and according to  IRS officials, the program may be expanded more slowly, if at all,  depending upon the evaluation results. Officials also said that test results  will contribute to a future decision about whether certification, if  continued, will precede the filing season or be part of the filing season as it  will be this year.
section_title: Input from Focus Groups and Others Has Resulted in Changes and May Result in More
paragraphs: On the basis of stakeholder input, focus groups, and other input, IRS has  made several changes to the planned certification test in addition to those  discussed previously. IRS held informal meetings with external and internal  stakeholders, focus group meetings with taxpayers and paid preparers, and  one-on-one interviews with third parties to share the certification letters,  forms, and/or instructions and obtain views on aspects of the new process.  In response, IRS took several actions, including revising the forms. As of  August 2003, IRS was evaluating comments received during the 30-day  public comment period, which IRS officials said may result in additional  changes.
IRS held several informal meetings with external and internal parties with  an interest in the qualifying child certification program. In March 2003, the  Stakeholder Partnership, Education, and Communication Organization  and the National Taxpayer Advocate held four informal meetings with  various external stakeholders, such as representatives of the National  League of Cities, the Boston EIC Coalition, and the American Institute of  Certified Public Accountants. Similarly, IRS officials coordinated the  certification initiative with internal stakeholders, such as representatives  from the Compliance unit, Wage and Investment operating division, Small  Business/Self Employed (SB/SE) operating division, and Forms and  Publications unit. The purpose of these meetings was to discuss the EIC  certification proposal and share the drafts of the two new certification tax  forms—Form 8836, “Qualifying Children Residency Statement,” and Form  8856, “Qualifying Child Relationship Statement.” Officials told us they  received comments from these groups of stakeholders and revised and  improved the forms based on the feedback received. For example, for the  residency form IRS added a list of community-based organizations and a  list of acceptable third parties from which IRS would accept affidavits.
After incorporating the recommendations from these informal meetings,  officials said they felt comfortable with testing the Form 8836, its  instructions, and the accompanying letter in other ways, including focus  groups, one-on-one interviews, and a 30-day public comment period.
In June 2003, a contractor conducted nine focus groups, five with taxpayers  who claimed EIC in tax year 2002, and four with tax preparers who had  prepared returns for taxpayers claiming EIC. In addition to the focus  groups, the contractor also conducted nine one-on-one interviews with a  cross section of the third parties listed on Part IV of the Form 8836 (the  participants were landlords, employers, and child care providers). The goal  of the testing was to determine whether individuals understood the  documents and thought they could obtain the requested supporting  documents and whether the suggested third parties would be willing to sign  the affidavit.
The focus groups and interviews were held in Philadelphia, Chicago,  Dallas, and Los Angeles. These cities were selected because of their high  EIC population. The participants were selected using screening guidelines  developed by IRS in conjunction with the contractor. Taxpayers were  selected on the basis that they claimed the EIC for tax year 2002 with a  qualifying child. Similarly, preparers were selected on the basis that they  worked as a tax preparer on federal tax returns for 2002 and prepared tax  returns for clients claiming EIC with a qualifying child. Those selected for  one-on-one interviews represented a cross section of the types of  individuals IRS deemed credible to provide affidavit information about the  EIC claimant. In total, 816 people were contacted and 109 agreed to  participate in the focus group testing. Of the 109, 88 persons arrived for the  testing and 81 actually participated in the focus groups. For the one-on-one  interviews, 12 individuals were qualified to participate and 9 actually  participated in the interviews.
Key IRS officials were on site during the focus groups and one-on-one  interviews to observe the participants’ comments. A variety of comments  were received and some changes were made. For example, IRS highlighted  where taxpayers and third parties were to sign the forms. Although the  contractor’s report of these meetings was not available before the public  comment period, IRS officials who attended the meetings concluded that  they had not received any feedback that would preclude moving forward  with getting comments from the public.
During the comment period, anyone could write or go to IRS’s Web site and  provide any comments or opinions about the qualifying child certification  program, including the form IRS expected to use and the data it planned to  request to prove eligibility. According to IRS, during the 30-day public  comment period, IRS received about 200 communications containing  comments. Any other comments about the certification program are due by  December 31, 2003. In addition, individuals can comment on the  certification process during the filing season until April 15, 2004. As of  August 2003, IRS officials were reviewing the comments received and  anticipated making additional changes to the forms and publications  shown in appendix V.
section_title: Our Concerns with IRS’s Recertification Were Considered as IRS Designed the Qualifying Child Certification Program
paragraphs: IRS officials told us they considered the recommendations in our  recertification report when planning their certification program. We agree  that our applicable recommendations have been considered. Whether the  strategies IRS adopted to deal with the concerns that led to our  recertification report recommendations are successful will not be known  until IRS evaluates the certification test.
Our recertification report described three aspects of the recertification  process that caused problems for taxpayers. Specifically,  one form used for recertification was of questionable value to IRS and  another form was potentially confusing to taxpayers;  taxpayers were asked to submit information that was difficult for them  to obtain or inconsistent with what many IRS examiners considered  acceptable; and  IRS examiners’ inconsistent assessment of documentation submitted by  taxpayers could result in different recertification decisions for  taxpayers in similar circumstances.
IRS has taken steps to deal with all of these concerns in designing the  certification process. Regarding the problems with recertification forms,  the form that was of questionable value to IRS, which was essentially a  means for taxpayers to tell IRS that they wished to be considered for  recertification, is not applicable to the certification program. The other  recertification form told taxpayers what they had to submit to establish  their eligibility for the EIC. We found that this form could confuse  taxpayers into believing they had to show that a qualifying child was also  their dependent, a criterion not applicable to EIC eligibility. We also found  that the form provided insufficient guidance to taxpayers on what  information they needed to provide to prove that qualifying children met  the EIC eligibility requirements. We made several recommendations,  including that IRS should clarify taxpayers do not need to demonstrate that  qualifying children are also dependents, help taxpayers better understand  what documentation they need to provide to establish their relationship  with any qualifying children, eliminate a requirement that statements from  child care providers be notarized, and encourage taxpayers to submit more  than one type of documentation.
Regarding our concerns about taxpayers who were recertifying being  asked to submit documentation that was difficult for them to obtain and  that tax examiners did not all accept, we found, for example, that EIC  taxpayers’ living arrangements could make providing various documents  difficult. We also found taxpayers did not always understand that school  records were for a calendar year and therefore needed to cover the spring  and fall of separate school years. We also found situations in which IRS  examiners would not accept a document even though the recertification  form listed the document as being acceptable. This concern overlapped  with our finding that IRS examiners’ were inconsistent in their assessment  of whether documentation provided by the taxpayers was sufficient to  establish their qualifications for the EIC.
Regarding our concerns about inconsistent documentation, IRS again took  actions intended to deal with our concerns in developing the certification  program. By introducing a new option—obtaining an affidavit affirming  that a qualifying child resided with the taxpayer for more than half the  year—IRS intended to give taxpayers another means of showing that the  residency requirement is met, which would prevent the taxpayer having to  obtain the other types of documents that the draft certification form lists.  Although IRS did not, as we recommended, create a new form to be used by  taxpayers when seeking school records, it did follow our alternative  recommendation that IRS clearly remind taxpayers that they need records  for part of 2 school years. The information is included in the certification  form’s instructions, which contain an example where a taxpayer must  provide records from 2 school years. Finally, by centralizing the EIC  certification processing in one location—Kansas City—and providing  training to those who will be involved, IRS is seeking to ensure a higher  level of consistency in how tax examiners judge whether taxpayers  adequately establish that qualifying children meet the residency criterion  for EIC.
Whether the manner in which IRS took our recertification  recommendations into account when designing the certification program  will be successful will not be known until IRS evaluates the certification  test.
section_title: Qualifying Child Certification Program Developed to Improve Compliance While Considering Taxpayers’ Burden, but Plan for Evaluating Test Is Incomplete
paragraphs: The certification program appears to be adequately developed to  potentially improve EIC compliance with consideration for minimizing  taxpayer burden so that testing should proceed, particularly in light of IRS’s  recent announcement further delaying the program’s start and reducing the  sample size. For example, the EIC task force and IRS have taken steps that  directly minimized the number of taxpayers who will be burdened by the  certification program. That is, the certification proposal is based on  analyses of the leading sources of EIC errors detected in earlier studies,  thus focusing attention and burden on the subset of taxpayers making  those errors, as opposed to all EIC recipients. In addition, IRS has taken  steps to address the burden taxpayers will experience as participants in the  certification test this year.
Although IRS has made and is continuing to make progress in defining its  plan to evaluate the certification test, the plan is incomplete.  For example,  the draft plan does not indicate how and when some information that will  be needed to evaluate whether certification achieves its objectives will be  obtained and analyzed.  However, officials recognize the draft plan needs to  be further developed and the importance of doing so quickly.
subsections: section_title: Initial Design and Subsequent Changes May Improve EIC Compliance and Have Helped to Minimize Burden
paragraphs: In initially designing and subsequently modifying the EIC certification  program, officials took into account the burden that taxpayers may  experience while attempting to improve compliance. Officials designed the  program to include, and thus burden, only the taxpayers most likely to  make the errors that contribute most to the EIC’s overclaim rate. By  focusing on these noncompliant taxpayers, IRS expects to improve EIC  compliance.  In addition, officials took a number of steps, such as obtaining  input from external and internal stakeholders that resulted in changes and  delaying the program while considering comments received during the  comment period, which should reduce the burden on those taxpayers who  are identified to certify.
To help improve compliance, the task force focused on known sources of  noncompliance including claiming nonqualifying children, filing status, and  misreporting income. To deal with errors attributable to claiming  nonqualifying children, the task force proposed a program for certifying the  eligibility for qualifying children and envisioned targeting taxpayers most  likely to make those errors. In contrast, other benefit programs that we  reviewed generally require all applicants to provide documentation before  receiving assistance. For example, to receive Supplemental Security  Income, an individual must visit a Social Security office, meet with a  representative, and provide documentation including birth certificates and  payroll information.  The Social Security Administration then matches this  information to determine eligibility in advance of benefits being received.  IRS’s certification effort, even if fully implemented, would require only a  subset of all EIC taxpayers to provide documentation to support their  eligibility and only when IRS is unable to verify eligibility from other  sources of information.
After the proposal was formally adopted, IRS took a number of steps in  developing plans for implementation that have been intended at least in  part to minimize the burden that taxpayers actually asked to certify would  experience, including the following.
IRS has undertaken more activities than usual to ensure the residency  form and other explanatory documents related to the certification  program have been reviewed by those who would use them.   IRS  sought feedback from focus groups and stakeholders on various aspects  of the certification test and the draft letter, form, and instruction  proposed for the residency test, such as whether taxpayers will be able  to obtain and provide documents within the time available, and made  some changes to the proposed form due to that feedback. As previously  described, IRS held focus groups with taxpayers, paid tax preparers, and  other parties to obtain feedback on certification. Officials also  interviewed a small number of third parties who would be called upon  to provide requested documents. IRS also held a 30-day open period to  receive comments from any interested party and expects to revise  certification materials due to comments received. Finally, IRS officials  say they will again revisit, among other things, the appropriateness of  the forms and explanations going to taxpayers after evaluating the  results of this year’s test of certification.
IRS considered the issues we raised in our report about the  recertification program when planning for certification. For example,  as discussed previously in this report, IRS developed a standard form  that includes an affidavit, which taxpayers can provide to third parties,  such as an employer, as an alternative to obtaining other documents to  prove residency. We also noted in our report that examiners  inconsistently accepted or declined supporting documentation for  recertification purposes. To address this concern, IRS officials  conducted special training and have all certification examiners in one  location, Kansas City, where EIC claims will be processed.
IRS provided taxpayers with a variety of documentation choices in  order to prove eligibility for their qualifying children. To certify for  residency, taxpayers will need to provide Form 8836, “Qualifying  Children Residency Statement,” with one or more of the following  supporting documents:  school records, medical records, day care provider records, leases, or  social service agency records that show the parent’s name and the  child’s name and address, and the dates that the child lived with the  parent; or  a letter on official letterhead for a qualifying child from the child’s  school, health care provider, landlord, or member of the clergy that  shows the parent’s name and the child’s name and address, and dates  that the child lived with the parent; or  a third party affidavit from a clergy member, community-based  organization official, health care provider, landlord or property  manager, school official, or day-care provider.
IRS dropped for an undetermined period of time, its plan to ask  taxpayers to certify their relationship to qualifying children. IRS officials  do not know whether or if they will test certification of relationships in  the future. Various external stakeholders had expressed concerns about  whether taxpayers would be able to provide the type of documents,  such as marriage and birth certificates, which IRS had planned to  request to document relationships to qualifying children on time. Also,  IRS officials said that the relationship portion of the program was  dropped for other reasons, including that (1) studies that have shown  relationship requirements to be less of a compliance issue than  residency and (2) taxpayers found to be noncompliant because of  relationship requirements often were also noncompliant due to  residency errors. As a result, certification will only include residency  this year.
As part of its effort to balance burden with ensuring compliance, IRS  made the changes listed above.  As we drafted this report, it had not yet  determined what additional changes it would make to the forms on the  basis of comments received during the 30-day public comment period,  but officials said more changes will likely result. As previously  discussed, the initial design of the residency form was responsive to  concerns we raised in our earlier report on IRS’s recertification  program. Additional changes, especially dropping relationship  recertification, were responsive to the concerns that stakeholders  raised before the public comment period. Accordingly, the current draft  residency certification form addresses many burden concerns.
section_title: IRS’s Plan for Evaluating the Test Is Incomplete
paragraphs: Although IRS has made and is continuing to make progress in defining its  plan to evaluate the certification test, the plan is not yet complete.  From its  inception, the certification program was intended to: (1) reduce the EIC’s  overclaim rate, (2) minimize burden on taxpayers and (3) maintain the  EIC’s relatively high participation rate. Although there are many ways to  organize an evaluation, determining whether the major objectives of a  program are accomplished should help policymakers determine whether  and how to proceed with the program. The draft plan is not explicitly  organized to show whether certification’s objectives are achieved, but does  present some information on how IRS would evaluate these objectives.  However, the plan proposed potential options for identifying how and  when some critical data will be obtained and analyzed, but does not  provide further details on when decisions will be made on specific data that  will be collected, how, and by whom. Officials recognize that the draft plan  needs to be further developed and the importance of doing so quickly.   They have, for instance, developed preliminary drafts identifying additional  data needed and have begun considering how to use contractors to gather  the data. Because evaluating these objectives will depend in part on actions  of EIC certification participants that will now occur as part of next year’s  filing season, IRS appears to have some time before it must make final  decisions on how it will determine whether the objectives were met.
Although an evaluation plan may not have to completely identify all issues  that need to be evaluated and precisely how they will be evaluated before a  program begins, the more completely such a plan is developed before a  program is implemented, the more likely that the evaluation will be  sufficient to support future decisions. For example, identifying key  questions that need to be answered before a project’s implementation  increases the chances that necessary data will be collected to answer those  questions. IRS’s Internal Revenue Manual recognizes the desirability of  having evaluation plans in place before a project is implemented. For  instance, it requires such plans before reorganizations.
IRS has been preparing an evaluation plan for the certification test and has  a draft plan, dated April 22, 2003. That draft describes how IRS expects to  evaluate the program and the process IRS used to select taxpayers for the  test.
The draft plan identifies one “threshold” question for evaluating the  certification program: whether the claimant selected for the test provided  the required information to allow IRS to determine the eligibility of  qualifying children regardless of whether the claimant was determined to  be eligible or not. The plan lists data that are to be gathered throughout the  certification program to answer this question.
The threshold question is part of what must be included in determining  whether certification for residency helps lower EIC overclaims, but  additional information is needed. Although not tying methodologies or  planned data collection specifically to whether certification lowers the EIC  overclaim rate, the draft plan has a combination of approaches that should  contribute to answering this question. For example, the draft plan  identified data that IRS would gather throughout the test on how many  taxpayers in the test sample certify or fail to do so in advance of the filing  season as well as how many prove that children meet the EIC residency  test during the filing season.
The extent to which certification may reduce overclaims due to qualifying  children not meeting the residency requirement, however, will depend  significantly on why some taxpayers will not attempt to certify and why  some will fail to claim the EIC, or as much EIC, for tax year 2003 as they  did for 2002. The draft plan takes into account that some taxpayers may  receive the certification materials, determine that a child does not meet the  residency test, and therefore not attempt to certify and not claim the EIC  with their 2003 tax return or claim EIC on another basis. IRS expects to use  available data to help assess whether the taxpayer had a filing requirement  and whether the taxpayer may have been eligible to claim the EIC (e.g., did  the taxpayer’s income fall within the appropriate range?). In addition, the  draft plan proposes that IRS use a contractor or another third party to  gather information from taxpayers about why they did not claim the EIC. A  subsequent document cites ideas for the types of questions that could be  asked.
Regarding the burden certification imposes on taxpayers who participate,  the plan is not organized to show how this will be evaluated, but it  recognizes that participants’ burden should be evaluated. For example, the  data IRS plans to collect throughout the process will have some utility in  answering this question. IRS will keep track of the number of  communications back and forth between IRS and the taxpayer before a tax  examiner makes a final certification decision. IRS’s plan also recognizes  that some information on burden will need to be collected directly from  taxpayers. The plan includes a general description of a potential opinion  survey that would gather burden-related information from certification  participants. Little or no detail is provided on how taxpayers would be  selected for such a survey, what types of questions would be asked, and  when the survey would be done; however, some of this information is  shown in a subsequent draft document. Because taxpayers will not have  completed their certification experience until sometime next filing season,  IRS has some time to decide whether to do such a survey and how to define  its parameters.
Regarding the objective of maintaining the EIC’s relatively high  participation rate, the draft plan proposes to obtain information from those  taxpayers who are asked to certify, do not, and then fail to claim the EIC.  The plan proposes to use a contractor or other third party to gather  information from these taxpayers about why they did not claim the EIC.  The plan does not amply describe how and when final decisions would be  made about selecting contractors or another third party to do this, when  the contractor would contact taxpayers, or what data they would attempt  to obtain from the taxpayers. Because the population IRS will need to  contact for these surveys will not be known until during and after the  spring of 2004, IRS has a number of months to further develop and  implement an approach.
Recognizing that its plans need to be further developed, IRS officials have  continued to explore how the evaluation will be done.  For example,  officials have drafted ideas for the type of survey questions a contractor or  other party would ask of EIC taxpayers to help IRS assess why taxpayers  take, or do not take, various actions (such as why they may stop claiming  the EIC after being asked to certify eligibility) and to assess taxpayers’  experiences under the certification program, including the burdens they  experience.  In addition, officials have begun identifying potential  contractors who would perform the surveys and considering contracting  options.  According to IRS officials and documents, some discussions have  been held with potential contractors to gain a better understanding of ways  to test the survey instruments, techniques available to ensure the best  possible response rate, and the number of taxpayers needing to be  contacted to have useful results.
Finally, because IRS would like to undertake some version of the qualifying  child program next year, possibly including certification during the latter  part of 2004, the timely production of evaluative data for this year’s test will  be critical for supporting decisions about what form future efforts will  take. IRS is aware of the tight schedule. Officials note that while they will  not have complete information on which to base some decisions about  whether and how to continue with implementation in 2004 before those  decisions must be made, they expect to have preliminary data in a timely  fashion. For example, IRS will not be able to completely answer whether,  and if so, why, taxpayers who are legitimately qualified to receive the EIC  do not claim it when they file their 2003 tax return until the end of the 2003  tax filing season, or later if taxpayers request a filing extension. IRS does  expect that its contractor will have contacted many, if not most, of the  taxpayers who file returns before the end of the filing season and do not  claim EIC. Thus, IRS expects to know during the fall of 2004 why many  taxpayers in the certification test stop claiming the EIC.
section_title: Some Implementation Issues Not Reviewed
paragraphs: We did not evaluate some implementation issues because they were  outside the scope of our review, still under development, or the Treasury  Inspector General for Tax Administration had audits planned in these  areas. Nonetheless, implementation issues could affect whether IRS is able  to fully implement the certification test and ultimately improve  compliance. We did not assess (1) whether IRS assigned an appropriate  number of staff to assist taxpayers with questions and process the forms  and documents relating to certification, (2) the adequacy of training  materials for staff or the procedures put in place to help examiners  consistently accept or decline taxpayers’ supporting documentation,  (3) the design or reliability of the databases that will be used to capture and  evaluate program information, and (4) supporting tools, which examiners  will use to do their job.
IRS has developed broad plans for processing the certification workload.  Officials identified about 30 different offices that will be affected by the  new certification program. As a key part of its processing strategy, IRS  plans to dedicate employees at its Kansas City campus to process cases,  answer a special toll-free number, and make updates to a certification  database based on responses from the test of the 25,000 taxpayers. The  Kansas City site will have about 180 staff, the bulk of whom will come on- board between September and December 2003. Approximately 40 staff  took initial training between April and June 2003.
section_title: Conclusions
paragraphs: Given the persistently high EIC overclaim rates, that the certification  program is a test, and that IRS has taken key steps to address burden issues  and focus the test on individuals least likely to meet the qualifying child  residency requirements, we believe IRS has struck a reasonable balance  between preventing unreasonable burden on EIC taxpayers and balancing  the need to obtain information on whether certification can be a useful  approach to improving EIC compliance.  In addition, with the recent  program changes announced in August, it appears that IRS is taking even  more steps to be mindful of these concerns.  Although certification during  the 2004 filing season gives IRS somewhat more time to modify the forms  and take other actions to potentially further reduce the burden on  taxpayers subject to the test, it also creates new challenges for IRS.  The  test will no longer be a direct test of the original concept of certifying  taxpayer eligibility in advance of the filing season.  Instead, testing will  occur during the filing season—IRS’s busiest time of year—and gives IRS  only indirect evidence on how well certification may work before the filing  season as originally envisioned.  Further, because IRS currently plans for  taxpayers to have to successfully provide proof of eligibility when they file  their individual income tax return or have a refund frozen until they do, a  greater portion of the taxpayers chosen for the test may have their refunds  delayed than if certification had been done before the filing season.  Finally,  like virtually all aspects of the qualifying child certification program, IRS’s  future plans have yet to be determined and are largely dependent of the  results and subsequent evaluations of this test.
For various reasons, we did not review in detail some implementation  issues, such as staffing and procedures for handling taxpayer responses,  which could affect whether IRS is able to successfully implement the  certification test. Thus, our opinion on whether IRS is ready to proceed is  based only on whether it has adequately developed the test to prevent  unreasonable burden and to improve compliance.
Although the balance IRS has struck supports proceeding with the test,  IRS’s plan for evaluating the certification program test is incomplete.  IRS  recognizes the need to evaluate the test and is developing its plan to do so.  For some key test objectives, IRS has preliminarily identified some data  that it believes must be collected to determine whether certification’s  objectives are achieved and has broadly identified when and how that  information will be collected.  Because the data are related to taxpayers’  actions that will occur later this year or next spring, IRS appears to have  some time to finalize its evaluation plan.
section_title: Recommendations for Executive Action
paragraphs: Given that the qualifying child certification program is a key part of IRS’s  plans for reducing EIC overclaims and that certification is intended to help  reduce overclaims while minimizing the burden on taxpayers and  maintaining the EIC’s participation rate, the Commissioner of Internal  Revenue should, to the extent possible, accelerate development of the  evaluation plan for the test. The plan should demonstrate how each of the  certification’s objectives will be evaluated, including milestones for such  critical steps as defining the specific data that will be collected, who will  collect the data, and how the data will be analyzed in time to support  decisions about the future of the program.
section_title: Agency Comments and Our Evaluation
paragraphs: While not explicitly agreeing with our recommendation, in his September  22, 2003, letter, the Commissioner of Internal Revenue said that IRS would  be including the components we suggested in their evaluation plan and said  that IRS is working to incorporate these components well before the  certification test begins.  The Commissioner said that our discussion of the  evaluation plan is essentially accurate, but provided an enclosure to his  letter that noted supplemental information on the plan. We are aware of the  information described in the enclosure to the Commissioner’s letter, and  considered it when drafting our report.
The Commissioner also raised concerns about the comparability of EIC  error rates to the error rates in taxpayers’ reporting of certain types of  income.  We concurred that, by-and-large, the compliance data on reporting  of these types of income are not comparable to the EIC error rate.  As a  result, we no longer show those comparisons in our final report.
We are sending copies of this report to the Chairmen and Ranking Minority  Members of the Senate Committee on Finance and the House Committee  on Ways and Means. We are also sending copies to the Secretary of the  Treasury; the Commissioner of Internal Revenue; the Director, Office of  Management and Budget; and other interested parties. We will make copies  available to others on request. In addition, the report will be available at no  charge on the GAO Web site at http://www.gao.gov.
This report was prepared under the direction of Joanna Stamatiades,  Assistant Director. Other major contributors are acknowledged in  appendix VII. If you have any questions about this report, contact Ms.  Stamatiades at (404) 679-1900 or me on (202) 512-9110.
section_title: Significant Noncompliance Rates Other Than for the EIC
paragraphs: The IRS has compliance data on some taxpayer groups such as individuals  and small businesses and some tax items such as income and credits.  By- and-large, the compliance data IRS currently has are not comparable to the  EIC. IRS is implementing its National Research Program (NRP), which will  provide new compliance data in 2004.  In the meantime, IRS is using its  Strategic Planning and Performance Management process to prioritize  compliance issues.
The compliance data that IRS has available for some taxpayer groups and  tax items are largely based on the Taxpayer Compliance Measurement  Program (TCMP), which was last conducted in 1988. However, these data  cannot be compared to the EIC overclaim or error rates, in part because  these data are 15 or more years old and reliable inferences cannot be drawn  because much of the tax system and the economy have changed during that  time. In addition, the methods used to calculate compliance rates for TCMP  are different than those used to calculate EIC.
In late 2002, IRS began implementing its new NRP, a detailed study of  individual taxpayers’ compliance. As part of NRP, IRS has identified a  random sample of approximately 47,000 returns from tax year 2001 and is  in the process of verifying the information on the returns through reviews  of IRS and third-party data. Where necessary to confirm the accuracy of  taxpayer-reported information, IRS is conducting either correspondence or  face-to-face examinations. IRS intends to conduct additional NRP reviews  of additional types of taxpayers, such as small corporations, and use the  NRP periodically to measure compliance of individual taxpayers.
The NRP sample of 47,000 returns includes about 7,300 EIC returns. These  EIC returns are subject to the same processes as the other returns in the  sample, and will include a review of the taxpayers’ eligibility for the EIC. In  order to determine whether the NRP review of these returns will yield  results methodologically similar to those of the 1999 EIC compliance study,  IRS is also comparing the results of the 1999 compliance study with NRP by  putting a sample of returns from the 1999 study through NRP processes  (not including examinations). According to IRS officials, this should allow  them to see the impact of the methodological differences between the  compliance study and NRP review.  IRS expects the results of the  comparison study by September 2003. IRS plans to have preliminary NRP  results in May 2004 and final results in November 2004.
Until better compliance measurement data are available, IRS’s  organizational divisions use the Strategic Planning Budgeting and  Performance Management process to prioritize the compliance problems  IRS faces. Through this process, IRS says that it (1) identifies and explores  critical trends, issues, and problems, (2) develops operational priorities  and improvement projects to address existing or emerging problems,   (3) explores drivers of program resources in order to develop resource  allocation targets for carrying out the proposed strategies, and (4) enables  division commissioners and the senior leadership teams to prioritize the  strategies and projects and determine the resource requirements to apply  to each strategy, operational priority, and improvement project.
Based on managers’ judgments made during this process, the Small  Business/Self Employed (SB/SE) operating division, for example, identified  its top six compliance priorities for fiscal year 2003 and 2004:  high income nonfilers (income greater than $100,000),  abusive offshore financial transactions,  promoter investigations (those selling tax schemes to others),  abusive tax avoidance transactions,  high income taxpayers (income greater than $1 million), and  returns with a high probability of unreported income.
SB/SE, which conducts few examinations of EIC claims, did not consider  EIC in this prioritization exercise since EIC has its own dedicated  appropriation. Because IRS used different means to identify and prioritize  these potentially noncompliant taxpayer groups, their identification as  SB/SE priorities does not mean their noncompliance rate is comparable to  noncompliance rates established for EIC or rates, which will be determined  through the current or future NRPs or other EIC compliance studies.
section_title: Overclaim Rates, Administrative Costs, and Eligibility Verification Processes of Benefit Programs
paragraphs: In addition to the data we complied on IRS’s EIC and qualifying child  certification program, we also compiled overclaim rate and administrative  cost data, as well as information on the eligibility verification processes, for  nine other federal or state benefit programs. We selected the nine benefit  programs because each requires some type of certification for benefits,  similar to the EIC, and because the EIC task force reviewed the same  programs. We did not do a comprehensive analysis to determine which  programs, if any, are most comparable to the EIC, nor did we determine  whether the information reported is comparable across programs.
The overclaim rates, administrative costs, and the eligibility verification  processes for the EIC and the other nine benefit programs—- Unemployment Insurance, Supplemental Security Income, Social Security  Disability Insurance, the National School Lunch program, the Food Stamp  program, Housing and Urban Development rental assistance, Medicaid,  Medicare, and Temporary Assistance for Needy Families—-are shown in  table 4.
Overclaim rates for programs other than the EIC for which data were  available ranged from 0.2 to 10.7 percent. These overclaim rates reflect the  percentage of total dollars paid out in error, not, for example, the  percentage of claimants who made errors. To calculate the overclaim  rates, most of the nine agencies selected a sample of program participants  and conducted a detailed analysis of the cases. This can involve collection  of additional supporting documentation, personal contacts with employers  and other third parties, or home visits to program recipients. A description  of how the overclaim rates were calculated is in table 5.
Administrative costs range from $123 million to $11.9 billion for the nine  programs. Administrative costs reported by federal agencies are likely not  comparable across programs and may not include all of the costs involved  in administering the programs. For example, various agencies and entities  at the federal, state, and local levels have administrative responsibilities  under the National School Lunch program. However, while the federal  budget provides funds separate from program dollars to pay for  administrative processes at the federal and state level, officials at the local level pay for administrative costs from program dollars that include federal  and state funding and student meal payments.
The process used to determine and validate eligibility varies significantly.  Some programs, such as the school lunch program, rely primarily on self- reported information and verification is limited. Other programs, such as  the Food Stamp program, require program staff to conduct extensive  verification.
To the extent known, how the overclaim rates are calculated, for the nine  benefits program we reviewed, including EIC, is shown in table 5.
section_title: Objectives, Scope, and Methodology
subsections: section_title: Objectives
paragraphs: We were asked to respond to 12 questions about IRS’s certification  program, as shown in table 6.
In consultation with our requesters’ offices, we grouped these questions  into three objectives, as follows: (1) describe the design and basis for the  EIC qualifying child certification program as proposed by the EIC task  force, (2) describe the current status of the program, including significant  changes since program approval, and (3) assess whether the program is  adequately developed to (a) prevent unreasonable burdens on EIC  taxpayers and (b) improve compliance so that the test should proceed. In  addition, we were asked to provide readily available information on   (1) significant noncompliance rates other than for the EIC and (2) the  overclaim rates and administrative costs of comparable benefit programs  administered by states or the federal government and any verification  process used by these programs.
section_title: Scope and Methodology
paragraphs: To respond to all of the questions, we reviewed and analyzed relevant IRS  and other documentation, such as compliance reports, EIC task force  reports, draft letters and forms, testing and focus group records,  implementation plans, evaluation plans, and our prior products, and  interviewed Department of the Treasury and IRS officials involved in the  EIC certification program, including the Assistant to the Commissioner; the  National Taxpayer Advocate; Research, Analysis, and Statistics officials;  and members of the qualifying child certification implementation team. We  did not verify the accuracy of the data shown in the various reports that we  reviewed. Rather, we reviewed the steps IRS had taken to implement the  certification program and determined, to the extent possible, how IRS  ensured that the program had been adequately developed to prevent  unreasonable burden and improve compliance. We did not evaluate  whether IRS’s preparations for implementing the certification test, such as  staffing and training, were sufficiently developed to support proceeding  with the test, because they were outside the scope of our review, still under  development, or the Treasury Inspector General for Tax Administration  had audits planned.
The first objective includes, in order, our response to questions 10, 4, and 6.  To determine the current EIC error rates and whether any studies had been  done on the impact of recent statutory changes on error rates, we reviewed  IRS’s most recent compliance study, the Treasury Inspector General for Tax  Administration reports and our previous reports, and interviewed IRS  officials. In addition, we reviewed the legislative history of recent statutory  changes—effective since 1999—that pertained to EIC. We analyzed these  data and IRS and Treasury reports to determine whether an analysis on the  impact of the legislative changes on EIC error or overclaim rates had been  conducted. To determine the range of alternatives considered by the task  force, we reviewed documents and interviewed members of the EIC task  force. To determine the correlation between overall EIC error rates, filing  status, and gender, we interviewed officials from Research, Analysis, and  Statistics and analyzed their data, and reviewed the EIC task force reports  and Treasury’s past compliance studies.
The second objective included, in order, our response to questions one,  five, two, and seven. To determine the status of the EIC certification  program, including the number and types of taxpayers to be contacted, we  interviewed IRS and Treasury officials and reviewed documents showing  timelines and key milestones. We reviewed plans for the certification  program, such as IRS’s Concept of Operations and the 2004 Increment  Evaluation Plan, in conjunction with IRS’s current process for evaluating  EIC eligibility. To calculate the percentage of EIC claimants subject to  certification in 2004, we divided the planned sample size by the number of  EIC claimants with qualifying children. To obtain information on IRS’s  testing of letters, forms, and documents for understandability, we observed  the focus group testing that IRS conducted in Dallas, Tex., with EIC  taxpayers, tax preparers, and other parties to understand how IRS assured  itself that such persons understood the forms and thought they could  obtain the required documentation. For whether items of concern we  found within the recertification program could have similar concerns in the  new initiative, we analyzed our prior reports on IRS’s recertification  program and IRS’s progress in implementing our recommendations, then  we compared our analysis to the certification plans.
The third objective includes, in order, our responses to questions eight and  three. To make our determination as to whether the program had been  adequately developed to improve compliance with minimal burden to  taxpayers, we asked IRS officials to describe and provide documentation to  support the steps they took to assure that the program was adequately  developed. This included interviews and a high-level review of key steps  and decisions found in various documents, such as the EIC task force  reports, the Concept of Operations, staffing plans, training materials, and  the evaluation plan. To determine the potential extent of the burden on  taxpayers, we reviewed reports from outside groups that analyze programs  and policies for low-income groups. We obtained the opinions of IRS  officials and discussed those of outside stakeholders, such as  representatives from the Annie E. Casey Foundation, low income taxpayer  clinics, and large tax preparation organizations, that IRS had met with  about any problems taxpayers might have in complying with the  documentation requirements to establish EIC eligibility. We also  interviewed IRS officials and reviewed EIC task force documents to learn  about the range of alternatives taxpayers have available to obtain similarly  reliable documentation, if they were unable to comply with the  certification documentation requirements.
Our responses to questions 11 and 12 are in appendixes I and II,  respectively. To determine the error rates of non-EIC taxpayer groups  having significant compliance issues, we reviewed compliance research  reports, interviewed officials about IRS’s National Research Program, and  reviewed information contained in the Strategy and Program Plan. We  discussed our analysis with key IRS officials, including representatives of  the Assistant to the Commissioner. To determine the overclaim rates,  administrative costs, and verification process of comparable benefit  programs administered by states or the federal government, we researched  our prior reports and contacted our staff knowledgeable about the selected  programs. We selected nine programs to review: Unemployment Insurance,  Supplemental Security Income, Social Security Disability Insurance, school  lunch, food stamps, Housing and Urban Development rental assistance,  Medicaid and Medicare, and Temporary Assistance for Needy Families. We  chose these programs largely because they were the same programs the  EIC task force reviewed and because each of them had some sort of  precertification program. We did not do a comprehensive analysis to  determine which programs, if any, were most comparable to the EIC, nor  did we determine whether the information reported for each program was  consistent and could be compared across programs. We did not do  additional analyses to determine how administrative costs compared to  program outlays.
Our response to question nine is in the background section of this report.  To determine the current process for determining EIC eligibility, we  reviewed relevant IRS documents and our prior reports. We verified the  accuracy of this information in interviews with IRS officials.
We conducted our work in Atlanta, Ga., Dallas, Tex., and Washington, D.C.,  from May 2003 through September 2003 in accordance with generally  accepted government auditing standards.
section_title: Key Milestones for the Qualifying Child Certification Program
paragraphs: Key milestones for the certification program for fiscal years 2002 through  2005, are shown in figure 4.
section_title: Documents Related to the Precertification Program
paragraphs: According to agency officials, IRS will send each of the 25,000 taxpayers  subject to precertification four documents, including (1) Notice 84-A, a  letter informing taxpayers about the new program; (2) Form 8836,  “Qualifying Children Residency Statement;” (3) Publication 3211M, “Earned  Income Tax Credit Question and Answers;” and (4) Publication 4134,  “Free/Nominal Cost Assistance Available for Low Income Taxpayers.”  Copies of these documents, current as of September 2003, follow.
section_title: Comments from the Internal Revenue Service
section_title: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Acknowledgments
paragraphs: In addition to those named above, Tiffany Brown, Evan Gilman, Veronica  Mayhand, Kathryn Larin, David Lewis, Donna Miller, Libby Mixon, Cheryl  Peterson, and Tom Short made key contributions to this report.
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