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. 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. 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.