The EIC is a refundable tax credit available to low-income, working taxpayers. Congress created the credit in 1975 to offset the impact of Social Security taxes on low-income families and encourage low-income workers to seek employment rather than welfare. The amount of a taxpayer’s credit depends on the number of qualifying children who meet age, relationship, and residency tests and on the nature and amount of qualifying income. Taxpayers with children can claim the EIC if they (1) have at least one EIC qualifying child, (2) meet income tests, (3) file with any filing status except “married filing separately,” and (4) were not a nonresident alien for any part of the year. To claim the EIC without a qualifying child, taxpayers have to meet requirements 2, 3 and 4, be at least 25 but less than 65 at the end of the year, have lived in the United States for more than half the year, and must not be claimed as a dependent on another return. The credit amount gradually increases with increasing income, plateaus at a maximum amount, and then gradually decreases (in a “phase-out range”) until it reaches zero when the taxpayer’s earned income or AGI exceeds the allowable maximum. Taxpayers with AGI falling in the credit’s phase-out range are to receive the lesser amount resulting from using their earned income or AGI in calculating the credit. Recently, Congress made changes to EIC eligibility rules in the Personal Responsibility and Work Opportunity Reconciliation Act of 1996 (P.L. 104-193) and the Taxpayer Relief Act of 1997 (P.L. 105-34). These changes, affecting returns filed for tax year 1996 and after, denied the EIC to any taxpayer with investment income over a certain threshold ($2,250 for tax year 1997); defined a “modified AGI” to be used in calculating the credit that excludes certain losses from investments and businesses; denied the credit to taxpayers without valid Social Security numbers (SSN); excluded certain workfare payments from wages for EIC purposes. Table 1 compares the maximum EIC amounts and income limits for tax years 1994 and 1997. IRS checks individual returns, with and without the EIC, for compliance while the return is initially being processed and in the months after filing. Some noncompliance involves mathematical errors and other obvious mistakes made by taxpayers or their representatives in preparing the returns. Other noncompliance involves mistakes that can be detected only through an audit of the return. The easiest EIC mistakes to identify and correct are those that IRS classifies as math errors. These errors, identified as the return is processed, include EIC computation errors and certain qualifying errors (e.g., missing SSNs for taxpayers and their children). For returns filed on paper, staff in IRS’ service centers are to enter tax return and Schedule EIC data into computers that check for math errors. If a math error that affects EIC eligibility or the size of the EIC claim is found, IRS is to reduce or deny the EIC accordingly. IRS is to then send a notice to the taxpayer explaining the change to his or her tax liability and refund. Taxpayers have 60 days to protest IRS’ actions, either in writing or by telephone, and to provide additional data supporting their original claims. If taxpayers do not respond to IRS’ notice, they are to get no further correspondence from IRS about that matter unless they fail to pay any additional tax that was assessed as a result of IRS’ change. Returns that taxpayers attempt to submit electronically are subject to a series of computerized “filters” that screen the submission for accuracy and completeness. Submissions with computational mistakes or missing or invalid data are to be rejected. A taxpayer whose electronic submission has been rejected can either correct the mistake(s) and resubmit the electronic return or file the return on paper (with or without the corrections). If filed on paper, the return would be subjected to the math error procedures described in the preceding paragraph. The most serious form of noncompliance involves deliberate attempts to defraud the government through, for example, phony refund claims. IRS’ primary effort to identify fraudulent refund claims, including those involving the EIC, is the Questionable Refund Program (QRP), established in the 1970s and run by IRS’ Criminal Investigation Division. Using a scoring system based on known noncompliance patterns, an IRS computer program analyzes all incoming returns to identify those that are potentially fraudulent. Then, questionable refund detection teams in the 10 service centers are to perform more in-depth reviews and, if a return is considered fraudulent, stop any refund before it is issued. IRS’ examination units in service centers and district offices review other potentially erroneous EIC claims that do not meet the criteria for inclusion in the math error or questionable refund programs. Service center staff review cases that do not require face-to-face contact with the taxpayer. Cases requiring face-to-face contact are done by district offices. Questionable refund detection teams are to refer cases with EIC errors that are not considered fraudulent to the examination units. Examination staff may also review cases included in special enforcement or compliance research projects. When examination staff determine that an EIC claim is erroneous, they are to notify the taxpayer of that finding and advise the taxpayer of his or her appeal rights. If the taxpayer agrees with IRS’ finding or disagrees with the finding but fails to overturn it on appeal, the claimed EIC is to be disallowed or adjusted in accordance with the examiner’s findings. IRS has undertaken a series of EIC compliance studies in recent years. In the first study, IRS sampled returns with EIC claims that had been filed electronically during a 2-week period in January 1994. The results, which could be generalized only to electronic returns filed during that 2-week period, showed that 39 percent of the returns involved overstated EIC claims that represented 26 percent of the dollars claimed. To learn more about EIC compliance, IRS conducted a broader study of tax year 1994 returns filed both electronically and on paper. The results of that study, released in April 1997, are the subject of this report. In 1996, IRS began a third study involving tax year 1995 returns. As of June 1998, IRS had not completed its analysis of the data from that study. All three of these EIC compliance studies predated the SSN-related math error procedures that were first implemented in 1997. However, as noted later, IRS adjusted the findings of its tax year 1994 study to show what the noncompliance rate would have been if those procedures had been in place then. As part of a 5 year EIC compliance initiative begun in fiscal year 1998 and discussed later in this report, IRS plans to measure its progress in reducing the EIC overclaim rate through annual studies of returns filed with an EIC claim. According to IRS, the first study of about 2,500 tax year 1997 EIC returns filed from January through May 1998 is designed to provide a baseline measure of the validity of EIC claims and types of EIC errors. IRS’ time line for the study shows that it expects to have a final report prepared by December 31, 1999. The results of subsequent studies are to be compared with that baseline to identify changes in EIC compliance. Our objectives were to (1) evaluate IRS’ tax year 1994 EIC compliance study methodology to determine if the reported results were reasonably accurate, (2) identify the primary sources of EIC noncompliance found in that study, and (3) determine whether recent IRS compliance efforts are designed to address the primary sources of noncompliance. To evaluate IRS’ study methodology and the accuracy of IRS’ compliance study results, we reviewed written documentation on the study’s methodology, reviewed 122 case files, interviewed IRS and Treasury officials involved in the study, reviewed computer programs written by IRS and Treasury’s Office of Tax Analysis (OTA) that were used to create and edit the final dataset, and calculated confidence intervals for the data presented in IRS’ April 1997 report. To assess IRS’ methodology, we determined whether IRS used generally accepted social science standards, which include the use of (1) unbiased sample selection procedures, (2) data collection controls, (3) procedures to ensure quality of data used, and (4) appropriate statistical procedures to generalize the data gathered and analyzed. In doing so, we considered the following questions: Does the study population appear to represent the population of all EIC filers during the period from January 15 through April 21, 1995? Was the sample drawn in accordance with probability selection principles? Were sufficient data verifying compliance with all EIC eligibility requirements collected from the EIC claimant and other sources? Were IRS staff collecting the data knowledgeable of how to apply EIC eligibility rules? Did the data collection procedures include controls to help ensure consistency in the evaluation of cases? Was data entry into the final database verified? Was the database checked for internal consistency, outliers, and invalid codes? How precise were the reported overclaim estimates? We also reviewed available data on IRS’ design of the tax year 1997 EIC compliance study to see how, if at all, that study addressed problems we identified with the tax year 1994 study. To determine the primary sources of EIC noncompliance on tax year 1994 returns, we analyzed the tax year 1994 study dataset as provided by IRS and modified through OTA editing programs. All data are estimates based on the study sample. Accordingly, we calculated confidence intervals at the 95 percent confidence level to indicate the precision of the estimates. Unless otherwise noted, the confidence intervals for percentages are 5 percentage points or less; for other statistics, the intervals are 10 percent or less of the reported value. To determine whether recent IRS compliance efforts addressed the primary sources of noncompliance, we reviewed IRS documents to identify the scope of EIC-related activities and related implementation plans; interviewed officials responsible for designing and implementing EIC-related activities at IRS’ National Office, its Brookhaven, Cincinnati, and Fresno Service Centers, and its Northern California District Office; and obtained available data on the results of EIC programs. We did our work from September 1997 through May 1998 in accordance with generally accepted government auditing standards. We requested comments on a draft of this report from the Commissioner of Internal Revenue and the Secretary of the Treasury, or their designees. The Commissioner of Internal Revenue and Treasury Deputy Assistant Secretary (Tax Analysis) responded in letters dated July 2, 1998, and June 29, 1998, respectively. Their comments are summarized at the end of this letter and are reprinted in appendixes I and II. On July 1, 1998, we met with IRS officials, including the Deputy Chief of Operations, the Acting Assistant Commissioner for Customer Service, and the Assistant Commissioner for Research/Statistics of Income, to discuss the Commissioner’s comments. In addition, IRS and OTA provided technical comments on our draft. We made changes to the report in response to the comments where appropriate. IRS found that of $17.2 billion in EIC claimed during the January 15 to April 21, 1995, study period, taxpayers overclaimed $4.4 billion, or 25.8 percent of total EIC claimed. To determine whether this $4.4 billion overclaim estimate is reasonably accurate, we evaluated IRS’ study methodology. Our evaluation was based on the extent to which IRS used generally accepted social science standards for a research project of this kind. These standards include use of (1) unbiased sample selection procedures, (2) data collection controls, (3) procedures to ensure quality of data used, and (4) appropriate statistical procedures to generalize the data gathered and analyzed. Before discussing our analyses, however, it is important to put IRS’ study findings in perspective. For returns filed with an EIC claim, the tax year 1994 study was designed to evaluate taxpayers’ compliance with each EIC eligibility filing requirement, to produce an overall estimate of EIC amounts claimed in error, and to identify the sources of error. The study was not designed to detect or quantify EIC claims that taxpayers could have made, but did not. For example, the $4.4 billion overclaim estimate includes about $780 million in overclaims associated with errors in applying the AGI tiebreaker rule. That rule provides that if a child meets the conditions to be a qualifying child of more than one person, only the person who had the highest AGI may treat that child as a qualifying child. As the 1994 study was designed, if IRS determined under the AGI tiebreaker rules that a person claiming the EIC was not entitled to it because there was another person in the household with a higher income, IRS would disallow the claim and include it as an overclaim in computing the study results. However, because these overclaims are not offset by any claim that could have been made by the other person involved in the tiebreaker, the ultimate savings to the government could be less than $780 million. With this basic limitation in mind, we found that overall, IRS’ study was designed and conducted in such a way that it produced a reasonably accurate estimate of noncompliance on returns filed with an EIC claim. Although some issues with the study design affected the precision of the results, our analysis showed that these limitations did not affect the study’s major message or its usefulness in designing compliance approaches. IRS’ study is representative of taxpayers filing an EIC claim on a tax year 1994 return filed between January 15 and April 21, 1995. We found that IRS used an appropriate statistical sampling procedure to select the 2,046 returns included in the study, and the sample appears to represent taxpayers who filed an EIC claim during that period. As an indicator of whether the EIC study sample was representative of EIC returns filed during the study time frame, we assumed that study returns should have characteristics similar to EIC returns filed during the entire year, as measured in IRS’ SOI sample of tax year 1994 returns filed throughout 1995. IRS’ April 1997 compliance study report compared weighted data on the distribution of claimants by paper or electronic filing, filing status, number of qualifying children, AGI range, and source of income for the study sample and the full tax year 1994 SOI sample. With the exception of the percentage of EIC claimants reporting self-employment income (6.3 percent among taxpayers in the compliance study compared to 15.3 percent of taxpayers in the SOI sample), weighted compliance study data closely paralleled data based on the SOI sample. The apparent underrepresentation of claimants reporting self-employment income is discussed in more detail later. In evaluating how IRS collected data on the accuracy of taxpayers’ EIC claims, we considered the following criteria: (1) whether IRS collected sufficient data to verify each aspect of EIC eligibility, (2) whether field agents and case reviewers knew how EIC rules were to be applied, and (3) whether the study procedures included controls designed to ensure consistency among cases. After reviewing study documentation and selected case files, we concluded that overall, IRS’ study methodology met these criteria. IRS’ data collection proceeded in two stages: initial taxpayer interviews and supplemental data collection in the field and a final review of complete case files at the Cincinnati Service Center. For each taxpayer in the study, IRS built a case file including transcripts of prior years’ returns, the tax year 1994 return, associated information reports (W-2s and 1099s), information on duplicate use of or invalid qualifying child SSNs, and dates of birth for filers and their children. Field agents were given initial case files containing data available at the time, written instructions on the information required to verify the claim, and checksheets to record findings. These instructions and checksheets covered all aspects of EIC eligibility. Field agents were required to contact, in person, the taxpayer; employers; the transmitter of the electronically filed return, if any; and the paid preparer, if any. If additional information was needed to verify the claim, the agents were to contact neighbors, schools, or state agencies as appropriate. This type of face-to-face contact with the taxpayer was necessary to verify the claim because eligibility of qualifying children is self-determined; and, other than SSNs, IRS does not have third-party information that can be used to verify the children’s eligibility. Data collection by the field agents was followed by a “best and final” review at the Cincinnati Service Center. These reviewers had access to additional information, primarily third-party income reports, that was not available at the time the field agents contacted the taxpayers. Using this additional information, the reviewers made final decisions regarding disposition of the claim. Most of the taxpayer interviews and other field data collection were done by IRS special agents from the Criminal Investigation Division or revenue agents from the Examination Division. The service center reviewers were Criminal Investigation Division tax examiners. On the basis of our prior work, we consider these staff generally to be adequately trained in audit techniques and how to apply EIC rules. IRS’ study methodology included controls designed to ensure consistency among cases. IRS used standard data collection checksheets and written instructions as one means to ensure consistent data collection. In addition, after completing an investigation, the field agents were instructed to call a study coordinator at IRS’ Cincinnati Service Center to discuss the case. This study coordinator was to review the findings to ensure completeness and consistency with other cases before the case was sent to the Cincinnati Service Center for final review. In spite of these controls, we found one consistency-related issue, regarding the corrected filing status for married taxpayers who erroneously filed as head of household, that may have systematically affected the study findings. This issue is discussed in more detail later. In reviewing IRS’ procedures for ensuring the quality of final study data used, we considered whether IRS (1) verified data entry into the final database; and (2) checked for internal consistency, outliers, and invalid codes. We found that OTA staff did a comprehensive review of the database to find and correct internal consistency and data transcription errors. This review of the data was necessary because IRS did not verify data entry or check for internal consistency within case records as the database was created. We verified data entry of key variables for the 122 cases included in our case file review and found no data errors. We used the OTA-corrected data for our analysis. IRS and OTA used the data to estimate the total amount of EIC overclaimed by the population represented by the sample of taxpayers filing EIC claims from January 15 to April 21, 1995. We replicated this analysis and arrived at the same totals. Data from the study are estimates based on the sample of EIC returns. To indicate the precision of these estimates, we calculated confidence intervals at the 95 percent confidence level. For example, as shown in table 2, IRS determined that taxpayers overclaimed a total of $4,448 million in EIC. The 95 percent confidence interval for this estimate is $412 million (– 9.3 percent of $4,448 million). This indicates that we are 95-percent confident that the actual overclaim amount is between $4,036 million and $4,860 million. The confidence interval for the 25.8 percent overclaim rate ranges from 23.4 percent to 28.2 percent. As shown in table 2, taxpayers with no qualifying children accounted for only a small portion of the EIC dollars claimed for tax year 1994 and $81 million of the overclaim total. The 95 percent confidence interval is $24 million to $138 million. Besides the overclaim estimate in table 2, IRS included in its report an estimate of total underclaims by taxpayers filing a tax year 1994 return with an EIC claim. That estimate was $293 million and has a confidence interval of $129 million to $457 million, or – 56.0 percent of the point estimate. The sample of taxpayers with underclaimed EIC is too small to allow IRS to make reliable estimates by number of qualifying children. Through our review of IRS’ study methodology, we identified two issues that affected the final study results. These issues are (1) apparent underrepresentation in the sample of claimants reporting self-employment income on a Schedule C and (2) apparent inconsistencies in correcting the filing status of married taxpayers who erroneously filed as head of household. Although we were not able to precisely quantify their net impact, our analysis showed that neither of these issues was large enough in scale to alter the major study findings. Filers who report self-employment income on a Schedule C appear to be underrepresented in the tax year 1994 EIC study sample. SOI data for all taxpayers who filed in 1995 show that 15.3 percent of EIC claimants reported Schedule C income. In contrast, 6.3 percent of claimants in the EIC compliance study filed a Schedule C. Self-employment income is often not subject to third-party information reporting; consequently, IRS has found that Schedule C filers in general are more likely to misreport their income than are taxpayers with wage income. A change in income, however, will often result in an incremental change in the EIC rather than a full denial. The impact of underrepresenting Schedule C filers in the tax year 1994 study is unknown and depends on how the filers left out of the sample might differ from those included. IRS’ ongoing compliance study of tax year 1997 EIC returns includes specific sampling of Schedule C returns and will sample through May; that study should be more representative of Schedule C EIC filers. Inconsistencies in determining the correct filing status for married taxpayers who erroneously filed as head of household also may have affected the final overclaim estimate. Taxpayers who use a filing status of married filing separately are ineligible for the EIC. Married taxpayers filing a joint return can claim the EIC if their joint income is within the eligible income range and they meet other qualifying criteria. When a taxpayer erroneously claimed head of household and was living with his or her spouse, the data collection instructions for the tax year 1994 study specifically directed field agents to use the filing status most advantageous to the taxpayer, usually married filing jointly (with appropriate changes to income, dependents, exemptions, etc.). We, and OTA staff who also reviewed case files, found instances in which field agents did not follow these instructions. The $4.4 billion overclaim estimate included $631 million accounted for by taxpayers whose filing status was changed by IRS to married filing separately in the absence of qualifying child errors and whose EIC was denied completely. It appears that some of these taxpayers may have been eligible for the EIC had IRS prepared a joint return; and, to the extent that their joint income would have allowed an EIC claim, the $631 million may be overstated. Although this filing status issue reduces the precision of the study findings, particularly in terms of identifying sources of noncompliance, we believe its impact to be relatively minor given the size of the total overclaim estimate. IRS data collection instructions for the tax year 1997 study state that field agents should attempt to obtain a copy of the spouse’s 1997 return to insert into the case file when filing status is changed to married filing jointly or married filing separately. However, the instructions did not specifically state that married filing jointly should be the presumptive filing status. The largest source of noncompliance found in the tax year 1994 study relates to the EIC requirements most difficult for IRS to verify—those related to the eligibility of qualifying children. As shown in figure 1, taxpayer returns with qualifying child errors accounted for at least 65 percent of the $4.4 billion in overclaims—56 percent from returns with qualifying child errors only and an additional 9 percent from returns with qualifying child errors made in conjunction with a filing status change to married filing separately. Claiming a child who did not meet residency requirements was the most common qualifying child error, and errors claiming head of household status often occurred with claims for nonqualifying children. Misreported income accounted for another 16 percent of the overclaim total; taxpayers whose filing status was changed to married filing separately, in the absence of qualifying child errors, accounted for most of the remainder. In order for a taxpayer to claim a qualifying child, the following rules applied for tax year 1994. 1. Relationship: The child must have been the taxpayer’s son, daughter, adopted child, grandchild, stepchild, or eligible foster child. A foster child is defined as any child cared for as the taxpayer’s own.2. Age: The child must have been under age 19, or under age 24 and a full-time student, or any age and permanently and totally disabled. 3. Residence: The child must have lived in the United States with the taxpayer for more than half of the year or the entire year for foster children.4. AGI tiebreaker: If a child meets the conditions to be a qualifying child of more than one person, only the person who had the highest AGI may treat that child as a qualifying child. This rule does not apply if the other person is the taxpayer’s spouse and they are filing a joint return. For example, if a child meets conditions to be a qualifying child for both a parent and grandparent who share a household and the grandparent has a higher AGI, the grandparent must claim the child. If the grandparent’s AGI exceeds the maximum income threshold, neither the parent nor the grandparent may claim the EIC for that child. As shown in table 3, qualifying child errors were involved in overclaims totaling $3.1 billion. About $1.7 billion of that amount involved qualifying children who did not meet the residency test, either alone or in combination with a failure to meet the relationship test. Failure to apply the AGI tiebreaker rules added an additional $782 million in overclaims. Together, these two types of qualifying child errors accounted for about half of the $4.4 billion overclaim total. As noted earlier, however, IRS’ study did not offset overclaims by claims that could have been made by other taxpayers. For example, in AGI tiebreaker cases, it is possible that the taxpayer with the higher AGI might have been able to claim an EIC. It is also possible in residency cases that a taxpayer in the household where the child actually lives could make an EIC claim for the child in question. The extent to which AGI tiebreaker and residency cases involved an EIC claim that could have been made by another taxpayer, but was not, is unknown. Filing status per se does not affect either EIC eligibility or credit amounts, except for married taxpayers filing separate returns who are ineligible for the EIC. As shown in table 4, however, head of household errors occurred on returns accounting for $3.4 billion in overclaims, or about three-quarters of the $4.4 billion in overclaims on all returns. For taxpayers whose filing status was changed to single, qualifying child errors accounted for most of the overclaims. For taxpayers whose filing status was changed to married filing jointly, most of the overclaims were attributed to income errors. Among taxpayers whose EIC was denied because their filing status was changed to married filing separately, about 40 percent of the overclaim amounts were also associated with qualifying child errors. Among all taxpayers who filed as head of household for tax year 1994, regardless of final filing status, male taxpayers had an overclaim rate nearly twice that of female taxpayers. Of $3.2 billion in EIC claims by male head of household filers, $1.7 billion, or about 51 percent, was overclaimed. In contrast, female head of household filers overclaimed $2.0 billion, or about 25 percent, of $8.2 billion in EIC they claimed. Errors in reporting income, with no other eligibility errors, accounted for $708 million in EIC overclaims, or 16 percent of total overclaims. Included in this group are taxpayers who (1) used the correct filing status but misreported their income or (2) were married and erroneously filed as head of household or single and whose filing status was changed to married filing jointly. The filing status error, per se, had no impact on the EIC; however, when IRS changed the filing status to married filing jointly and modified the taxpayers’ returns to include the correct combined income for both parties, the EIC was often reduced or denied completely. These adjustments accounted for about $309 million of the income-related overclaims. In general, about half of EIC claimants use a return preparer rather than completing the return themselves. Using codes developed by OTA, we grouped prepared returns into the following three categories: those prepared by (1) “formal preparers,” which includes attorneys, Certified Public Accountants, national tax preparation companies, and enrolled agents; (2) “IRS preparers,” which includes staff at IRS walk-in sites and at IRS-supported volunteer organizations like Volunteer Income Tax Assistance and Tax Counseling for the Elderly; and (3) “local or informal preparers,” which includes anyone not in the other two categories. The study data show that there was little difference in EIC noncompliance between self-prepared returns and those done by preparers. Both groups had overclaim rates of about 26 percent. A more detailed analysis, however, shows that overclaim rates varied by type of preparer. As shown in figure 2, the rate on returns prepared by local or informal preparers was 31 percent; the overclaim rate on returns prepared by formal preparers was 20 percent. The sample included too few IRS-prepared returns to allow us to make a reliable overclaim estimate for that group. Knowing the extent to which EIC overclaims are due to honest mistakes versus intentional misstatements is important in targeting compliance approaches. If, for example, errors are due to a misunderstanding of EIC rules, taxpayer education and assistance efforts would be warranted. Taxpayers intentionally misclaiming the EIC require different approaches. As part of the tax year 1994 study, IRS made a determination of taxpayer intent. Both field agents and Cincinnati Service Center case reviewers were to classify taxpayers’ errors as intentional (e.g., the taxpayer knew that a child did not meet EIC qualifying child tests); or unintentional (e.g., the taxpayer did not understand the eligibility rules or EIC instructions). We found that field agents had not made determinations of intent in about 40 percent of the final overclaim cases. In almost all of these instances, however, Cincinnati reviewers made a determination of intent as part of their best and final review. Based on best and final case data, about one-half of the 4.7 million returns with an EIC overclaim and two-thirds of the total amount overclaimed were considered to be the result of intentional errors. These assessments are judgmental in nature and should not be considered precise measures of intentional and unintentional taxpayer errors. However, the results do indicate that IRS’ compliance efforts should include activities aimed at taxpayers who intentionally misclaim the EIC. Examiners working tax year 1997 compliance study cases are to collect data related to taxpayer intent. The data collection checksheet for that study includes a question asking examiners to decide if errors were due to complexity of the tax form, difficulty understanding the law, a computational error, a potential fraud scheme, or some other reason. This provides more specific choices, particularly for unintentional error, but the determinations of intent will still be judgmental. With new enforcement tools provided by Congress and an increase in funding specifically designated for EIC-related activities, IRS began implementing in fiscal year 1998 a plan that calls for attacking EIC noncompliance through expanded customer service and public outreach, strengthened enforcement, and enhanced research. Together, these activities constitute what we refer to as the “EIC compliance initiative.” Many parts of that initiative are targeted at the major sources of EIC noncompliance discussed in the prior section. However, in reviewing IRS’ efforts for tax year 1997, we identified several implementation issues that could diminish the initiative’s impact. As we have previously testified before Congress, IRS’ ability to reduce EIC noncompliance is limited by the design of the credit. Unlike income transfer programs such as Temporary Assistance for Needy Families and Food Stamps, the EIC is designed to be administered through the tax system rather than through other state or federal agencies. This choice generally should result in lower administrative costs and higher participation rates and emphasizes that the credit is for working taxpayers. The trade-off, however, is higher noncompliance. EIC eligibility, particularly related to qualifying children, is difficult for IRS to verify through traditional enforcement procedures, such as matching return data to third-party information reports. Correctly applying the residency test and AGI tiebreaker rules, for example, often involves understanding complex living arrangements and child custody issues. Organizations that administer programs like Food Stamps are set up to investigate and verify this type of eligibility before payment is made; IRS is not. Thoroughly verifying qualifying child eligibility basically requires IRS to do an audit of the type done in the EIC compliance studies—a costly, time-consuming, and intrusive proposition. IRS has designed some compliance efforts to reduce qualifying child noncompliance but cannot fully address a significant root cause—design of the EIC itself. Most of the efforts that make up the EIC compliance initiative had not progressed far enough at the time we completed our audit for us to make any judgment about their effectiveness. IRS plans to measure the overall impact of its compliance initiative on the EIC overclaim rate through annual studies of EIC compliance starting with a baseline study of tax year 1997 returns. However, the 5-year initiative could be into its fourth year before IRS has tax year 1997 and 1998 study data to compare in assessing the initiative’s results. That would be too late for IRS to identify and implement meaningful adjustments to the initiative. IRS plans to measure the results of individual programs implemented in 1998, but some of these results will not be available for planning fiscal year 1999 activities. Upon release of IRS’ April 1997 report on the results of its tax year 1994 EIC compliance study, the Department of the Treasury announced six legislative proposals directed at reducing EIC noncompliance. Congress included four of the six proposals in the Taxpayer Relief Act of 1997 (TRA97). Specifically, these provisions (1) require paid preparers to fulfill certain due diligence standards when preparing EIC claims for taxpayers; (2) provide that taxpayers who fraudulently claim the EIC can be denied the credit for 10 years, and those who recklessly or intentionally disregard the rules and regulations can be denied the credit for 2 years; (3) provide that taxpayers who are denied the EIC through IRS’ deficiency proceduresare ineligible to claim the EIC in subsequent years unless they provide evidence of their eligibility through a recertification process; and (4) allow IRS to levy up to 15 percent of unemployment and means-tested public assistance and certain other specified payments. In addition, TRA97 included provisions that (1) give IRS access to the Department of Health and Human Service’s (HHS) Federal Case Registry of Child Support Orders, a federal database compiling state information on child support payments that could help IRS identify erroneous EIC claims by noncustodial parents; and (2) require the Social Security Administration (SSA) to collect SSNs of birth parents and provide IRS with information linking the parents’ and child’s SSNs. Besides the new enforcement tools provided in TRA97, Congress began funding the EIC compliance initiative. For fiscal year 1998, the first year of what is to be a 5-year effort, Congress appropriated $138 million. For the second year (fiscal year 1999), IRS has requested $143 million. Funding over the full 5 years is expected to total $716 million. IRS is using the compliance initiative funds to expand existing EIC-related activities and to initiate several new efforts, including implementation of the TRA97 provisions. The various activities being funded as part of the EIC compliance initiative in fiscal year 1998 fall into three broad categories: (1) customer service and public outreach, (2) enforcement, and (3) compliance research. Primary efforts in each of those categories are listed in table 5. As indicated in table 5 and discussed in more detail below, several components of the EIC compliance initiative are directed at issues that were identified by the tax year 1994 EIC compliance study as major sources of EIC errors. To the extent that EIC errors, whether they involve qualifying children requirements, filing status, or misreported income, are unintentional and due to a misunderstanding of the rules, IRS’ customer service and outreach efforts may help improve compliance. IRS data show that many taxpayers took advantage of the expanded customer service IRS offered in 1998. For example, IRS expanded telephone access for EIC-related issues to 7 days a week, 24 hours a day. According to IRS data, 95,000 taxpayers called the EIC assistance lines during the times when IRS’ other assistance lines were not available. In addition, IRS provided Saturday walk-in assistance at between 152 and 173 sites from March 7 through April 11, 1998. IRS data show that staff available on these 6 Saturdays helped 2,949 taxpayers prepare their EIC returns and provided 1,032 others with different types of EIC-related assistance. According to IRS, this is in addition to 185,305 EIC taxpayers assisted on weekdays during the filing season. Some choices IRS made in implementing its assistance and outreach efforts in 1998, however, limited the number of persons who might have benefited. For example: IRS did not offer Saturday walk-in assistance until March 7, by which time millions of EIC claims had already been filed. IRS reported that it had received about 7.4 million EIC claims as of February 21, 1998—2 weeks before the first Saturday that walk-in help was available. EIC Awareness and Problem Prevention days were held even later in the filing season. IRS said that it did not offer Saturday service earlier in the year because “prior to receiving the [EIC] appropriation, we had anticipated having Saturday service for only the last six weeks of the filing season” when, according to IRS officials, demand among all filers is generally higher. The date for the EIC Awareness Day was selected so that IRS would have adequate time to publicize and provide for quality service to the public. IRS officials said, in retrospect, it could have been more effective if scheduled earlier. IRS did not advertise the 24-hour availability of telephone assistance for EIC-related issues. IRS informed taxpayers of this service only if they received a notice from IRS about a problem with the EIC claims on their tax returns. IRS officials told us that they did not advertise this service because they thought that it would lead to many non-EIC calls during the hours when other assistance lines were closed. As noted earlier, TRA97 included provisions that allow IRS to deny future EIC claims. These provisions are to be implemented in 1999, based on returns filed in 1998. For example, persons found to have intentionally disregarded the rules and regulations in filing their EIC claims in 1998 can be denied the credit for the following 2 years. IRS attempted to warn taxpayers about the implication of these provisions before they filed their returns in 1998. Those outreach efforts were intended to create a deterrent effect by providing an incentive for intentionally noncompliant taxpayers to file a correct return and for other taxpayers to be sure that they understand the EIC rules before filing. To the extent that result was achieved, the number of EIC errors may have been reduced. Although we have no way of knowing how successful those warnings were in encouraging better compliance, we believe that the chances for success might have been enhanced if IRS had done a better job of publicizing those warnings. In that regard, IRS’ income tax return instructions did not alert taxpayers as clearly as they could have about the TRA97 provisions and their implications. The tax year 1997 Form 1040 tax package included the following statement in its general information on “what’s new for 1997”: “Caution: If it is determined that you are not entitled to the EIC you claim, you may not be allowed to take the credit for certain future years. See [Publication] 596 for details.” A reference to this caution was not included later in the package either with the instructions for filling in the EIC line item on the tax return, the EIC worksheets, or the Schedule EIC that taxpayers must submit with their returns to substantiate their EIC claims. Thus, IRS was relying on taxpayers to read the general information in the front of the tax package before preparing their returns and, assuming they did, to order Publication 596 for details. For tax year 1996, about 19 million taxpayers claimed the EIC and IRS distributed about 636,000 copies of Publication 596. We believe that potential EIC claimants would have been more likely to read the relevant information from Publication 596 if it had been included in the Form 1040 instructions, along with statements in the EIC-specific parts of those instructions that clearly alerted taxpayers to the existence of that warning and where to find it. The customer service and outreach efforts discussed above are generally broad based and not targeted to specific sources of EIC noncompliance. In contrast, IRS’ compliance initiative includes several enforcement and research activities that are specifically targeted on issues relating to qualifying children, the head of household filing status, noncompliant return preparers, and misreported income. Qualifying child errors. IRS’ tax year 1994 EIC compliance study showed that qualifying child errors associated with the residency requirement and AGI tiebreaker rules accounted for about half of the $4.4 billion EIC overclaim total and 1.8 million of the 2.3 million returns with a qualifying child error. These errors undoubtedly included both unintentional mistakes and intentional noncompliance and involved a variety of complex living situations. IRS is able to verify some EIC eligibility criteria using tax return or Schedule EIC information and does so through its math error program as returns are submitted. IRS receives few indicators, however, of other problematic eligibility requirements, such as qualifying child residency or the presence of another taxpayer in the household who should be claiming the child. IRS has targeted its enforcement efforts on those compliance problems that can be identified from tax return information or profiles of noncompliant returns and is able to resolve some eligibility issues through correspondence audits. However, the bulk of noncompliance, primarily related to qualifying children, can best be identified through face-to-face audits. One component of the compliance initiative that combines elements of customer outreach and enforcement is targeted on cases where a qualifying child’s SSN is used on more than one tax return for the same tax year. Because a qualifying child can be claimed only once, resolution of these duplicate SSN cases should eliminate EIC claims by taxpayers with whom the child did not reside. For the outreach portion of this effort, IRS identified about 225,000 qualifying child SSNs that had been used by more than one taxpayer on tax year 1996 returns. In December 1997, IRS sent taxpayers using these SSNs (about 383,000 taxpayers) a notice informing them of the problem and reminding them to file a correct return for tax year 1997. To evaluate the effectiveness of these notices, IRS plans to check for duplicate use of these qualifying child SSNs on tax year 1997 returns. According to IRS, it plans to begin its evaluation in September 1998 and report the results in February 1999. For the compliance portion of this effort, IRS allocated additional staff to audit as many as 140,000 taxpayers who had used about 92,000 duplicate qualifying child SSNs in both tax years 1995 and 1996. According to IRS officials, as of May 16, 1998, about 103,000 of the 140,000 taxpayers had filed tax year 1997 returns, and IRS had frozen their refunds. Also as of May 16, 1998, however, IRS had released 49,000 of the refunds for taxpayers who had corresponded with IRS but whose conflicting claims for the child(ren) in question were not resolved. In discussing the release of these refunds, IRS officials told us that it could not process the amount of correspondence received because IRS (1) did not have enough time to adequately prepare for the start of this project (e.g., get staff assigned, procedures developed, and training done); and (2) had underestimated the volume of taxpayer contacts it would receive. Although IRS is continuing to investigate these cases, its effectiveness in protecting the revenue has been compromised because it is more difficult (and more costly) to recoup an erroneous refund once it has been released. IRS officials told us that meaningful data on the results of this effort would not be available until September 1998. Another way that IRS attempts to deal with qualifying child errors is to deny EIC claims when the taxpayer has failed to provide valid SSNs for the listed children. This effort, which is part of IRS’ math error program, began before the compliance initiative and has continued as part of the initiative. As of June 4, 1998, IRS had sent about 535,000 EIC SSN-related math error notices to tax year 1997 filers; at the same point in 1997, IRS had sent about 774,000 such notices to tax year 1996 filers. IRS data for all of tax year 1996 show that it stopped approximately $876 million in erroneous refunds through the EIC SSN math error program. As of March 1998, IRS data show that it stopped about $414 million in tax year 1997 refunds. IRS expected to issue fewer SSN math error notices in 1998 because IRS, before the 1998 filing season, had sent notices to about 600,000 taxpayers with known SSN problems telling them what to do to correct the situation before filing their tax year 1997 returns. TRA97 included provisions giving IRS access to an SSA data file linking parent and child SSNs and a Federal Case Registry of Child Support Orders to be administered by HHS. The Federal Case Registry is to be a compilation of state child support and custody data. Access to both data files is intended to augment IRS’ ability to detect EIC claims for nonqualifying children. Both, however, are still in development, and IRS plans to do a “feasibility analysis” regarding their use. However, it will be several years before IRS will be able to use these data. Access, in terms of the specific data fields IRS can obtain, is still a major issue to be resolved among the three agencies. In addition to access issues, IRS’ feasibility analysis is to include an assessment of data accuracy, currency, and completeness—factors that will be especially important for the custodial data to be useful. Filing status errors. IRS’ tax year 1994 study showed that a large proportion of qualifying child errors occurred in tandem with erroneous claims of head of household status. One of the components of the EIC compliance initiative involves increased staffing to expand a project aimed at a universe of about 345,000 head of household EIC claimants whose returns contain other indicators of potential qualifying child problems. This project was initiated in 1997 with audits of about 53,000 returns and expanded in 1998 to 313,000 returns. As of March 1998, about 50,700 of the 53,000 audits begun in 1997 had been closed; and about 43,400 of those closures (86 percent) resulted in tax changes totaling about $107 million. On the basis of those results, IRS expects that about 85 to 90 percent of the 1998 audits will result in a change to the EIC claim. According to IRS, results of these audits will not be available until late 1998 or early 1999. IRS officials estimated that about 25 percent of the 313,000 audits will be completed by September 30, 1998. Errors involving misreported income. Misreported income accounted for about 16 percent of the total EIC overclaims identified in IRS’ tax year 1994 EIC compliance study. Many of IRS’ traditional compliance activities are designed to identify returns with misreported income. For example, EIC returns are subject to IRS’ document matching program, which compares W-2 wage reports and other income information reports (e.g., those filed on Form 1099) with income reported on tax returns. Because misreported income is of particular concern within that segment of the population that reports self-employment income on Schedule C, the EIC compliance initiative includes a study of noncompliance among EIC claimants who report self-employment income. IRS selected a sample of tax year 1997 returns, held the refunds, and plans to complete the audits by September 1998. IRS plans to issue a report of its findings in February 1999. Paid preparer noncompliance. The tax year 1994 study data showed that returns prepared by local or informal preparers had a higher overclaim rate (31 percent) than the returns prepared by formal preparers (20 percent). To address preparer noncompliance, TRA97 imposed due diligence requirements on paid preparers who complete EIC returns and fines for preparers who fail to comply with those requirements. In December 1997, IRS issued specific due diligence requirements and publicized these requirements in mailings to practitioners. IRS did not institute at a national level specific procedures to monitor compliance with the due diligence requirements during the 1998 filing season. However, individual field offices may have done some monitoring. At the Northern California District Office, for example, we were told that staff phoned about 560 preparers in the district to inform them of the due diligence requirements and inquired into conformity with those requirements as part of the district’s normal monitoring visits to about 100 preparers. IRS informed us that national-level plans for the 1999 filing season include due diligence monitoring visits to EIC return preparers, but IRS has not decided on the procedures for these visits, the number of visits, or the extent to which they will target those preparers most likely to be noncompliant (i.e., local or informal preparers). As part of the EIC compliance initiative, IRS also planned to increase district office Criminal Investigation staffing in fiscal year 1998 to investigate potential EIC fraud cases, including cases involving return preparers. The increased staffing was to include a total of 40 special agents and 10 investigative aides. For fiscal year 1998 as of May 31, 1998, 31 paid preparer cases have been opened compared to 44 for all of fiscal year 1997. Fraud detection. IRS’ QRP is aimed at identifying tax returns with potentially fraudulent refund claims. The scoring system used to identify these returns is based on known characteristics of potentially fraudulent returns. As part of the compliance initiative, IRS expanded QRP staffing to allow screening of 1.3 million more returns in fiscal year 1998 than in fiscal year 1997, for a total of 4 million returns. According to IRS, as of April 30, 1998, QRP teams had scanned about 2.3 million potentially fraudulent EIC returns and had identified 6,476 returns with erroneous EIC claims totaling $17.6 million. As is evident from our discussion of the various elements of the EIC compliance initiative, there was little information available at the time we completed our audit work on the results of IRS’ efforts and thus little basis for us or IRS to assess their effectiveness. Such data and assessments are crucial as IRS decides on the compliance initiative’s future direction. An obvious question one would ask in assessing IRS’ results is “how much has the EIC overclaim rate changed since the start of the initiative?” Although the results of the tax year 1994 EIC compliance study were the catalyst behind congressional funding of the compliance initiative, IRS does not plan to use those results as the baseline for measuring the initiative’s impact on the EIC overclaim rate. Instead, it plans to measure the initiative’s impact against the results of a tax year 1997 compliance study, which IRS has begun as part of the initiative. However, by the time IRS completes the tax year 1997 study, which is to become the baseline, and a tax year 1998 study that can be compared with the baseline to measure change, IRS will be in the fourth year of its 5-year initiative. IRS’ time frame for the tax year 1997 baseline study shows that the analysis will not be completed until fiscal year 2000. If the tax year 1998 study follows the same schedule, its results will not be available until fiscal year 2001—the fourth year of the initiative. It will be too late at that point to make substantive changes to the initiative. Given the time frames associated with the broad compliance studies, it is important that IRS closely monitor the results of the initiative’s individual components so that it can make more timely and better informed decisions about revising, deleting, or expanding those various components. For example, information on the results of the notices IRS sent users of duplicate SSNs in December 1997 would be useful in deciding whether to send similar notices in December 1998. As noted earlier, however, IRS does not plan to begin such an assessment until September 1998 and does not expect to have final results until well after December 1998. Although minor methodological problems in IRS’ tax year 1994 EIC compliance study could have led to some over- or understatement of total EIC overclaims, these issues do not affect the relevance of the study’s findings. The study demonstrates that EIC noncompliance is a significant issue and that verifying qualifying child eligibility lies at the heart of EIC compliance problems. Targeting compliance efforts at qualifying child errors, however, presents IRS with a major challenge. IRS is not set up to systematically verify qualifying child eligibility. Doing so would basically require IRS to establish a process to verify eligibility before issuing a refund, similar to the processes used in EIC compliance audits. IRS’ EIC compliance initiative includes a broad array of customer service, enforcement, and research activities aimed at reducing noncompliance. Some parts, like special audits of head of household claimants and preparer due diligence requirements, are targeted specifically at areas of noncompliance identified in the tax year 1994 study. Others, like expanded walk-in and telephone assistance, are more broadly based efforts aimed at improving taxpayers’ understanding of EIC rules. Although it is too early to judge the initiative’s effect on noncompliance, we did identify some opportunities for IRS to improve future implementation efforts. For example, IRS did not offer Saturday walk-in assistance until late in the filing season when millions of EIC claims had already been filed. Also, for the TRA97 provisions allowing IRS to deny future EIC claims to act as a deterrent, taxpayers must be aware of the circumstances under which these penalties will be applied. IRS’ income tax return instructions, however, did not alert taxpayers as clearly as they could have about these provisions and their implications. IRS plans to do annual studies to measure the impact of its EIC compliance initiative on the overclaim rate. Based on IRS’ time frame for these studies, however, useful data on impact will not be available until fiscal year 2001—the fourth year of the initiative. It will be too late at that point to make substantive changes. Absent timely data on the overall impact of IRS’ efforts and given the need for IRS to ensure that available resources are used as effectively and efficiently as possible, it is important that IRS have immediate information on the results of individual components of that initiative. Evaluation plans that are not timed to provide data when data are most needed, as appears to be the case with IRS’ planned evaluation of the notices on duplicate SSNs, are of limited value. We recommend that the Commissioner of Internal Revenue ensure that customer service efforts aimed at EIC claimants be available earlier in the filing season when most EIC claims are filed, and include prominent information regarding the 2-year and 10-year sanctions and the recertification process in the Form 1040 EIC instructions and Schedule EIC. In addition, to provide a basis for continually improving and refocusing EIC compliance efforts, we recommend that the Commissioner develop evaluation plans for each compliance initiative component that will provide, in succeeding years of the initiative, timely data for decisionmakers. We requested comments on a draft of this report from the Commissioner of Internal Revenue and the Secretary of the Treasury, or their designees. The Commissioner of Internal Revenue responded in a July 2, 1998, letter generally agreeing with our recommendations (see app. I). On July 1, 1998, we met with IRS officials, including the Deputy Chief of Operations, the Acting Assistant Commissioner for Customer Service, and the Assistant Commissioner for Research/Statistics of Income, to discuss the Commissioner’s comments. Treasury’s Deputy Assistant Secretary (Tax Analysis) responded in a June 29, 1998, letter (see app. II). In response to our recommendation that IRS provide customer service efforts earlier in the filing season, IRS said that it plans to publicize EIC awareness events early in the 1999 filing season and to hold EIC awareness activities beginning in January 1999. IRS officials told us that (1) Saturday service at walk-in assistance sites during the 1999 filing season will begin on January 16 and continue through the filing season, and (2) the first 6 Saturdays will be publicized as EIC help days. These actions, if effectively implemented, will be responsive to our recommendation. In response to our second recommendation about more prominently displaying information on the 2-year and 10-year sanctions and the recertification process, IRS said that it will include such information in the tax year 1998 Schedule EIC instructions but will not revise the schedule itself. IRS said that it did not believe the Schedule EIC should be revised to address these issues because the issues do not affect the majority of filers and providing the information on the schedule may confuse filers who have not had their EIC claim disallowed. According to IRS officials, taxpayers must go to the worksheet in the instructions to complete the schedule, and IRS’ intent is to place the information so that persons using the worksheet will easily see it. Although inclusion of the information in the Schedule EIC instructions is an improvement, we continue to believe that something should also be added to the schedule. Because one of the purposes of this information is to alert potential EIC claimants to possible repercussions if they make erroneous claims, the information affects all filers. Also, although it is true that taxpayers who choose to compute their own EIC have to use the worksheet in the instructions, taxpayers who choose to have their returns prepared by someone else do not have to use the worksheet and thus would see only the Schedule EIC. We are not suggesting that all of the information on sanctions and recertification be included on the schedule. What we are suggesting is that a brief, but prominent, cautionary statement be added to the schedule alerting users to important information in the instructions that they should read before filing their returns. Regarding our final recommendation, IRS said that it understood our concern regarding more timely delivery of research data for decisionmaking. According to IRS, it has developed an information delivery strategy that includes developing information systems that will allow more timely delivery of both interim and final tax return, audit, and research data. The strategy includes using interim reports to disseminate preliminary findings from various EIC projects. For example, IRS officials said that they hope to have, in October 1998, some preliminary findings from audits of taxpayers who had used duplicate qualifying child SSNs. IRS also noted that using interim data of this sort has limitations; it may not be adequate to measure revenue or provide a full understanding of taxpayer behavior. Although there are certain limitations associated with interim data, we believe, as IRS recognized in its comments, that such data can be of value to decisionmakers. Treasury’s letter addressed two statements in the draft report—our characterization of the EIC as an income transfer program and our statement that IRS cannot address a significant root cause of noncompliance. In response to our statement comparing the EIC to other income transfer programs, Treasury said that “unlike income transfer programs, the [EIC] makes work pay by reducing tax liabilities,” and that about 80 percent of the EIC’s total costs offset individual income, Social Security, and other federal taxes. We clarified our reference to income transfer programs where appropriate. In response to our statement in a draft of this report that IRS cannot address a significant root cause of noncompliance (IRS’ difficulty verifying qualifying child eligibility), Treasury said that issues of verifying family relationships and living arrangements are not unique to the EIC but also affect taxpayers’ eligibility for dependency exemptions, filing status, the child credit, and the child and dependent care tax credit. Also, both IRS and Treasury said that they were hopeful that access to new data (an HHS registry of child support orders and SSA data linking parent and child SSNs) will allow IRS to detect some qualifying child problems during return processing. We modified our statement and related discussions in the report to acknowledge IRS’ ability to identify some noncompliance related to qualifying children. Our report also recognizes the provision in TRA97 giving access to the HHS and SSA databases. However, IRS told us that it will not be testing use of these databases until late 1999 or 2000 and that the amount of information that can be initially expected is small. As agreed with your offices, unless you publicly release its contents earlier, we plan no further distribution of this report until 30 days from the date of this letter. At that time, we will send copies to the Ranking Minority Member, Committee on Ways and Means; the Chairmen and Ranking Minority Members of other interested congressional committees; the Secretary of the Treasury; the Commissioner of Internal Revenue; and other interested parties. Major contributors to this report are listed in appendix III. If you or your staffs have any questions, please call me on (202) 512-9110. Earned Income Credit: Noncompliance Relative to Other Components of the Income Tax Gap (GAO/GGD-97-120R, June 13, 1997). Earned Income Credit: Claimants’ Credit Participation and Income Patterns, Tax Years 1990 Through 1994 (GAO/GGD-97-69, May 16, 1997). Tax Administration: Earned Income Credit Noncompliance (GAO/T-GGD-97-105, May 8, 1997). Earned Income Credit: IRS’ 1995 Controls Stopped Some Noncompliance, But Not Without Problems (GAO/GGD-96-172, Sept. 18, 1996). Earned Income Credit: Profile of Tax Year 1994 Credit Recipients (GAO/GGD-96-122BR, June 13, 1996). Earned Income Credit: Noncompliance and Potential Eligibility Revisions (GAO/T-GGD-95-179, June 8, 1995). Earned Income Credit: Targeting to the Working Poor (GAO/GGD-95-122BR, Mar. 31, 1995). Earned Income Credit: Targeting to the Working Poor (GAO/T-GGD-95-136, Apr. 4, 1995). Tax Administration: Earned Income Credit—Data on Noncompliance and Illegal Alien Recipients (GAO/GGD-95-27, Oct. 25, 1994). Tax Policy: Earned Income Tax Credit: Design and Administration Could Be Improved (GAO/GGD-93-145, Sept. 24, 1993). The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000 or by using fax number (202) 512-6061, or TDD (202) 512-2537. Each day, GAO issues a list of newly available reports and testimony. To receive facsimile copies of the daily list or any list from the past 30 days, please call (202) 512-6000 using a touchtone phone. A recorded menu will provide information on how to obtain these lists.

Summary: Pursuant to a congressional request, GAO reviewed the Internal Revenue Service's (IRS) 1994 Earned Income Credit (EIC) compliance study, focusing on: (1) evaluating IRS' study methodology to determine if the reported results were reasonably accurate; (2) identifying the primary sources of EIC noncompliance found in the study; and (3) determining whether recent IRS compliance efforts are designed to address the primary sources of noncompliance. GAO noted that: (1) IRS' estimate of $4.4 billion in EIC overclaims has a 95-percent confidence interval of $4 billion to $4.9 billion; (2) GAO's evaluation of the study methodology showed that the estimate is reasonably accurate and representative of EIC claimants filing between January 15 and April 21, 1995; (3) some aspects of the study methodology affected the precision of the results; but, given the scale of the findings, these limitations do not affect the study's message or its usefulness in designing compliance approaches; (4) although it is a reasonable estimate of EIC overclaims, the entire $4.4 billion should not be viewed as a potential savings to the government had IRS somehow been able to prevent or correct all of these errors; (5) for returns filed with an EIC claim, the tax year 1994 study was designed to evaluate taxpayers' compliance with each EIC eligibility filing requirement, to produce an overall estimate of EIC amounts claimed in error, and to identify the sources of these errors; (6) the study was not designed to detect or quantify EIC claims that taxpayers could have made; (7) the largest source of taxpayer error identified by the tax year 1994 study relates to EIC requirements that are difficult for IRS to verify--those related to qualifying children; (8) unlike income transfer programs, the EIC was designed to be administered through the tax system; (9) this choice generally should result in lower administrative costs and higher participation rates and emphasizes that the credit is for working taxpayers; (10) EIC eligibility is difficult for IRS to verify through its traditional enforcement procedures; (11) thoroughly verifying qualifying child eligibility requires IRS to do an audit of the type done in the EIC compliance studies; (12) with new enforcement tools provided by Congress and an increase in funding designated for EIC-related activities, IRS began implementing in fiscal year 1998 a plan that, over a period of 5 years, calls for attacking EIC noncompliance; (13) most of the efforts that make up the EIC compliance initiative had not progressed far enough at the time GAO completed its audit for it to make any judgment about their effectiveness; (14) IRS plans to measure the overall impact of the compliance initiative on the overclaim rate through annual studies of EIC compliance starting with a baseline study of tax year 1997 returns; and (15) IRS plans to measure the results of the individual initiative components implemented in 1998.