Document originally published in Tax Notes
on February 18, 2008.
This story represents the first step in an analysis of issues that low-income taxpayers face when filing their income tax returns. From now until April 15, contributing editor Joann M. Weiner will be volunteering at a return preparation site in the Columbia Heights neighborhood in the District of Columbia and learning firsthand the issues that low-income taxpayers face when filing their tax returns. With this experience, she hopes to be able to make some recommendations about the earned income tax credit program and the assistance granted to low-income taxpayers in general. She welcomes comments and suggestions on this project.
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At 3 p.m. on February 9 at the D.C. Tax Fair, I earned my reward.
I helped a low-income taxpayer complete and file the tax forms necessary to claim more than $3,000 through the earned income tax credit on her earned income of just over $10,000.
For two weeks I had been preparing to become a volunteer tax return preparer through the District of Columbia Earned Income Tax Credit Campaign (DC EITC) to help low-income taxpayers complete their tax forms. Before I could help taxpayers, however, I had to successfully complete the Volunteer Income Tax Assistance and Tax Counseling for the Elderly (VITA/TCE) certification course and exam. Part of my training involved taking a total of 12 hours of courses led by Barbara Mantegani, president of Community Tax Aid and a transfer pricing specialist with KPMG, and Phil Marti, a VITA volunteer since 1995 and a retired IRS employee with more than 25 years' experience at the IRS.
On February 7, I passed the test and became a certified volunteer return preparer. Two days later, armed with Publication 17, Your Federal Income Tax, and various VITA/TCE documents, I headed down to the D.C. Tax Fair at the Washington Convention Center.
D.C. Tax Fair
At the D.C. Tax Fair, first organized eight years ago by Del. Eleanor Holmes Norton, D-D.C., more than 125 volunteers from the IRS, the District of Columbia Office of Tax and Revenue, DC EITC, Community Tax Aid, the Justice Department, Howard University, the University of the District of Columbia, the National Association of Enrolled Agents, and many other volunteer organizations spent their Saturday helping 537 D.C. taxpayers file their federal and district tax returns.
The program's success is unquestioned, as taxpayer participation this year increased by more than 25 percent from last year. Nearly 30 workstations were staffed throughout the day by volunteers, and about a dozen expert return preparers were also available to answer questions and review returns as needed. Most federal returns were electronically filed at no fee, and the IRS will begin sending out the refunds on February 22.
I worked with Susan Nelson, a volunteer who is also a tax economist with the government and has volunteered with Community Tax Aid for five years. During our first day, we helped five women — Ella, Charlotte, Nina, Barbara, and Thelma, whose combined adjusted gross income was less than $58,000 — file their tax returns.
Each woman had her own particular tax issue to resolve. One retiree earned all of her income from her previous government work, another woman worked several jobs to earn $10,000 in 2007, and a third supported a disabled adult child on just over $10,000. Each woman was grateful to have a "professional" volunteer prepare her tax return.
When asked why she had come to the Tax Fair, one taxpayer said "the tax law is so complicated that I just can't figure it out."
After we spent about 15 minutes completing one taxpayer's relatively simple return, we asked whether she had considered preparing her own.
"Never," she replied. "I'm too afraid of making a mistake."
After we had spent more than an hour — including consultation with one of the nearby experts — on another return for a taxpayer from northwest D.C., she remarked, "How am I supposed to figure this out if it took the two of you this much time to figure out my tax return?"
Even the professionals, however, make mistakes. In one case, Susan and I struggled to figure out why a taxpayer appeared to owe a tax payment when she had earned so little during the year. Although it is embarrassing to admit, we had clicked the box on the worksheet indicating her current age rather than her retirement age, and we spent the next half-hour trying to figure out what we had done wrong. Fortunately, the IRS-developed TaxWise software alerted us to the error.
That situation might not have occurred — in fact, the worksheet would have been unnecessary — if the Office of Personnel Management had indicated the amount of her taxable annuity on its "Statement of Annuity Paid" instead of reporting it "unknown." Many volunteer preparers identified that failure to list taxable annuity amounts as one of the most easily solvable problems they encountered that day. I honestly do not know how that elderly taxpayer would have figured out the amount of taxable annuity without assistance.
For one taxpayer, not only did we determine that she was eligible for the EITC, we also found out that she had been eligible in previous years for the EITC but had not claimed it. She is therefore eligible to file an amended return for the past three years and receive the EITC she is entitled to.
The fact that 20 percent to 25 percent of eligible taxpayers do not claim the EITC is one of the overlooked statistics associated with the program. It is possible that some taxpayers' excessive EITC claims are entirely offset by others' failure to claim what they have coming to them.
The District of Columbia, 22 states, New York City, and Montgomery County, Md., offer local EITCs in addition to the federal credit. Only taxpayers with earned income below a threshold are eligible for the EITC, and the EITC is capped at relatively low levels of income.
For 2007, a single mother with one child must have an AGI of no more than $33,241 to be eligible for the EITC; her EITC is limited to a maximum of $2,853. Taxpayers with two or more children receive a maximum credit of $4,715, while taxpayers with no children are eligible for just $428.
Not all taxpayers who meet the AGI limits are eligible for the EITC. Taxpayers whose savings are "too high" — specifically, those with more than $2,900 in investment income — are ineligible for the EITC. Taxpayers claiming foreign earned income or the foreign earned income exclusion are also ineligible for the EITC.
EITC Pros and Cons
Many studies show that the EITC is one of the most effective tools for helping families escape poverty. For example, researchers at the Brookings Institution reported that in 2001, the EITC lifted more than 4.7 million people, including 2.2 million children, out of poverty. According to the national taxpayer advocate's 2007 report to Congress, taxpayers who claim the EITC receive an average refund equal to 20 percent of their annual income. (For the report, see 2008 TNT 7-12 .)
On this year's EITC Awareness Day, Treasury Secretary Henry Paulson announced that more than 22 million taxpayers received almost $44 billion through the federal EITC and another $1.5 billion in state EITCs last year. "That's money to pay bills and rent, to buy gasoline, books, and clothes; money that can provide a real benefit," Paulson emphasized.
The EITC is especially important to the District of Columbia. The D.C. Kids Count Collaborative recently reported that one out of three D.C. children lives in poverty and that more than half of those children live in homes with single mothers.
However, not everyone believes the EITC's benefit in assisting low-income families outweighs the potential for abuse of the system. Former lawmaker Ernest Istook, now a government relations fellow with the Heritage Foundation, has criticized the decision to provide rebate checks to those receiving EITC refunds. The list of EITC taxpayers who will also receive stimulus rebate checks is "dominated by fraud," according to Istook, who adds that one-fourth to one-third of EITC returns "are based on illegal multiple returns, phony Social Security numbers, and claims of non-existent children or even make-believe spouses" ("Congress Will Send Billions to Tax Cheaters," available at /taxbasehttp://www.heritage.org/Press/Commentary/ed020508a.cfm).
Fraud or Error?
This "fraud," however, may largely be due to complexity and inadvertent errors. As the Joint Committee on Taxation and Treasury have both noted, the complexity of the EITC causes much of the noncompliance. As Treasury noted in its fiscal 2009 budget blue book, for example, many errors "may have been caused by taxpayer confusion over unusual family situations and the complicated tax rules that were created to address these situations" (Doc 2008-2288, 2008 TNT 24-10 ).
Contrary to Istook's assertion, taxpayers cannot claim the EITC for nonexistent children. Taxpayers must provide valid SSNs to claim the EITC, and the IRS will reject tax returns that do not have proper SSNs.
In its study of 1999 tax returns, the IRS reported that the largest value of overclaimed EITCs was associated with taxpayers claiming a child who was not the taxpayer's qualifying child. Most errors relating to the qualifying child arise when a taxpayer incorrectly determines the child's residence. The EITC residency rules require that the qualifying child live with the person claiming the EITC for more than half the year. The residency error is particularly common in nontraditional families, such as those in which a grandparent raises a child, or those in which parents are recently divorced and the child splits time between the two households.
Mistakes related to the qualifying child and the child's residence are understandable. Until recently, the EITC, the dependent exemption, the head-of-household filing status, the child tax credit, and the child- and dependent-care tax credit all used their own definition of child. Although the definition was simplified somewhat for 2005 and later years, conflicting definitions continue to exist.
The EITC 'Death Penalty'
Not only is it easy to make mistakes in claiming the EITC, but those who make mistakes can also be punished for up to 10 years under section 32(k), a measure that many colloquially refer to as the "death penalty."
The Clinton administration introduced the penalty in 1997 in response to criticism from some, like then-House Ways and Means Chair Bill Archer, that the EITC program was "crying out for correction" and riddled with "errors and fraud" (Tax Notes, Apr. 28, 1997, p. 484).
Under section 32(k), if the tax authority determines that a taxpayer's error in claiming the EITC is due to "reckless or intentional disregard" of the EITC rules, then the taxpayer may not claim the EITC for two years even if the taxpayer is otherwise eligible. If the tax authority determines that the error is based in fraud, the taxpayer cannot claim the EITC for 10 years.
Taxpayers subject to the penalty would also have to be recertified by the IRS before they could claim EITCs again. Those filers face particular difficulties. A 2002 Government Accountability Office study shows that IRS recertification examiners rarely agreed on whether the facts presented would justify allowing the taxpayer to be recertified. (See Doc 2002-12825 or 2002 TNT 106-66 .)
As low-income taxpayer champions Nancy Abramowitz and the late Janet Spragens explained in 2005, "there is no other penalty in the code comparable to section 32(k) for any other type of conduct" ("Low-Income Taxpayers and the Modernized IRS: A View From the Trenches," Tax Notes, June 13, 2005, p. 1407, Doc 2005-11024 , 2005 TNT 113-38). "There are no comparable penalties or reinstatement procedures for misclaimed tax benefits, for any other taxpayers in the system, no matter how large the error."
For example, as burdensome as return preparer and accuracy-related penalties are (paid preparers may be subject to civil and criminal penalties and even permanently barred from preparing tax returns), unlike with the EITC, the tax shelter penalty does not apply each year for 10 years.
The tax code also penalizes tax return preparers who commit fraud or who assist in filing inaccurate returns. Under section 6695(g), return preparers who fail to comply with due diligence requirements in determining EITC eligibility "shall pay a penalty of $100 for each such failure." However, preparers may avoid the penalty if they can demonstrate to the IRS's satisfaction that the failure to meet due diligence was an "isolated and inadvertent" incident.
Thus, taxpayers who fraudulently claimed a $4,000 EITC would lose the credit for 10 years, for an effective $40,000 penalty, and would also possibly be subject to an accuracy-related penalty of 20 percent of the tax underpayment.
Return preparers who may have been responsible for that fraud — through error or intentionally — face a mere $100 penalty.
EITC and the Tax Gap
Because the EITC is refundable, unlike many other tax benefits, the IRS must be particularly vigilant in that area. Much of the outrage over the EITC arose from an IRS study (Doc 97-11528, 97 TNT 80-23 ) showing that $4.4 billion of the EITC was fraudulently claimed.
Treasury's August 2007 tax gap report (Doc 2007-18004 , 2007 TNT 150-15 ) notes that the individual income tax accounts for $245 billion of the $345 billion gross tax gap in 2001. Despite concern about EITC errors, Treasury does not mention the EITC as an element of the tax gap.
Spragens and Abramowitz noted that, using data for EITC claims made in 1999, the IRS indicated in a 2002 report that $8.5 billion to $9.9 billion in EITCs may have been erroneously paid. As a share of the tax gap, those EITC errors would account for a small fraction of the individual tax gap.
Thus, a much larger share of the tax gap is attributable to individuals who do not claim the EITC and who likely earn more than $50,000. However, the IRS does not subject those taxpayers to the same scrutiny as the EITC filers. Although the IRS conducted three major compliance studies of the EITC in 1994, 1997, and 1999, it did not conduct a single compliance study of the rest of the taxpaying population.
As Spragens and Abramowitz noted, "whether the EITC studies are accurate or not, the differential enforcement strategies for low-income taxpayers and others in the system [are] inappropriate."
It's easy to understand why taxpayers come to the volunteer centers to file their tax forms. A more difficult question is, why do the volunteers do it?
On D.C. Tax Fair day, Norton said that "most are rendering service today out of the goodness of their expert hearts."
Marti, the former IRS employee who teaches the volunteer assistance course, says he volunteers to "give back to the community" and because "taxes are so hard for some people and so easy for me."
Another volunteer, who works as a salesman, likes to "give people back the money they deserve."
A staffer with DC EITC volunteers so that low-income taxpayers do not have to pay preparers to file their returns for them. Many Tax Fair clients that day indicated that they had paid preparers in the past. According to the National Society of Accountants, the cost to prepare the state return and the individual Form 1040 without itemized deductions is about $115 on average. Despite EITC claimants' relatively low income, paid preparers filed more than 60 percent of tax returns claiming the EITC in 1999, but only about half the returns of those not claiming the EITC. According to one study, EITC recipients paid about $1.75 billion for return preparation, electronic filing, and refund anticipation loans.
A volunteer who works at the Kennedy Center participates because she is a recent college graduate and would like to learn how to file her own return while helping others file their returns.
Some students volunteer to prepare returns as part of their law or business courses.
Others are professional accountants who volunteer as part of their pro bono responsibility. One accountant said she and her roommates compete with each other to see who can obtain the greatest total tax refunds for their low-income clients in an evening.
With more than a decade of experience as a volunteer and course leader, Mantegani may have provided the best reason: "Why do I do this? Because I've seen this program change people's lives. Receiving the EITC refund could be the difference between being homeless and making the down payment for an apartment; between going to school and being stuck in a low-wage job; between getting the car fixed or taking three buses and spending two hours to get to work. Oftentimes, these people live paycheck to paycheck, and the EITC refund can help them get out of poverty. They're not going to Disneyland with their refund."
Claiming the Reward
As Mantegani said at the beginning of my first volunteer tax preparation course, "You'll earn your reward when you tell a taxpayer that she's receiving a $3,000 tax refund when she made only $10,000 all year."
She was right.
And I wasn't the only one to enjoy this reward. The taxpayer, the D.C. government, and the entire country benefit.
Taxpayers are the greatest beneficiaries. Because the IRS makes direct deposits for e-filed returns within 10 days or so, taxpayers who attended the D.C. Tax Fair are likely to see their refunds very soon.
The D.C. economy also benefits. Since each year D.C. taxpayers claim an average $1,050 in refunds, the Tax Fair will pump an additional $535,000 into the D.C. economy in just a few days.
Nationwide, more than 60 percent of taxpayers who claim the EITC file their returns during February. Based on filing figures from 2006, this means that roughly 26 million U.S. taxpayers will receive more than $13 billion in EITC refunds in February alone.
- The IRS Volunteer Income Tax Assistance program, created in 1969, offers free tax help to those who earn less than $40,000. The Tax Counseling for the Elderly program offers free tax help to taxpayers who are age 60 and older. The IRS maintains 70 taxpayer assistance centers in areas underserved by the volunteer tax preparation sites during the first three Saturdays in February. Nearly 12,000 free tax preparation sites are open across the country this year.
The DC EITC campaign is managed by Capital Area Asset Builders and coordinated by Meg Newman. More than 20 organizations provide in-kind and financial support to assist with planning and implementing the campaign.
By contrast, the IRS won't start sending out rebate checks from the recently signed stimulus bill (H.R. 5140) until late May. (For related coverage, see p. 771.)
Thus, putting billions of dollars of EITC refunds into low-income taxpayers' pockets in the next few weeks is a stimulus package indeed.