Special needs children are defined as those children who  a state determined cannot or should not be returned to a parent, and  using specified criteria, the state can reasonably assume that the child  will not be adopted without state assistance. Since the original provision was adopted in 1996, taxpayers have claimed  about $4.28 billion in adoption tax credits. For tax year 2010, taxpayers  filed almost 100,000 returns claiming the credit, with over $1.2 billion  claimed as of August 2011. This strategy included the following major  elements:    Communicating and reaching out to taxpayers, tax professionals,  Congress, the states, and adoption organizations, with the objective of  conveying information about changes in the law and documentation  requirements.   Requiring taxpayers claiming the credit to submit documentation that  the adoption of the child for whom credit was being claimed was  already completed or in progress (an adoption order or decree for a  completed adoption, or a home study, placement agreement, hospital  or court document, or lawyer’s affidavit for an adoption in progress),  along with IRS Form 8839. Taxpayers and Stakeholders Did Not Have Important Information on the Adoption Tax Credit

To inform taxpayers, paid preparers, state agencies, adoption advocacy  groups, and other stakeholders about the new law and documentation  requirements, IRS planned to use various means of communication, such  as its website, media releases, phone forums, webinars, Twitter accounts,  and YouTube recordings. In  addition, IRS did not make an effort to communicate to state adoption  program managers or convey information about documentation  requirements for claims involving special needs children, which could  have helped state adoption managers better inform adoptive parents who  asked them what documentation to provide to IRS. In  June 2011, IRS revised its training materials and the Internal Revenue  Manual to indicate that a state agreement to provide adoption assistance  under Title IV-E of the Social Security Act was sufficient proof of special  needs status, but did not include examples of adoption assistance  agreements in the revised materials. IRS Can Reduce the Number of Audits in 2012

For the 2011 filing season, IRS screeners automatically directed all  returns on which taxpayers claimed the adoption tax credit and where  documentation was either missing or of uncertain validity to  correspondence audit (audits by mail). A senior IRS official acknowledged  that this process resulted in a large number of adoption credit–related  correspondence audits and diverted IRS resources from other more  productive audits. As of August 6, 2011, IRS had sent 68 percent of almost 100,000 returns  it had processed on which taxpayers claimed adoption credits to  correspondence audit. IRS reported that it ended up disallowing all or a  portion of the credit for only about 6,000 (17 percent) of the approximately  35,000 returns on which audits have been completed and assessed   $17.7 million in additional tax.   Finally, IRS could institute a procedure by which, immediately  following initial screening of the return, it would send a letter to  taxpayers who did not provide any documentation, notifying them of  what documentation is needed. IRS has not yet determined whether sending a letter upon initial  screening would lead to a significant number of taxpayers submitting  documentation after receiving the letter, thus reducing processing time  and the number of audits. IRS officials told us that data from the 2011  filing season on the number of claimants who submitted documentation  while undergoing a correspondence audit should help determine whether  sending an initial letter after screening the return would be more effective. In reviewing its  strategy for the 2012 filing season, IRS has an opportunity to reduce the  time and resources spent on correspondence audits of adoption tax credit  claims as well as the number and length of refund delays while still  maintaining a robust enforcement strategy. Recommendations for Executive Action

For the 2012 filing season, we recommend that the Commissioner of  Internal Revenue instruct appropriate officials to    ensure that the communications effort specifically includes state and  local adoption officials, and clarifies acceptable documentation for the  certification of special needs adoptees;    provide examples of adoption assistance agreements that meet the  requirements for documenting special needs status, from each state  and the District of Columbia, in training materials given to reviewers  and examiners;    place the agreements on its website to help taxpayers better  understand what constitutes acceptable documentation; and    determine whether requesting documentation in cases where no  documentation is provided before initiating an audit would reduce the  number of audits without significantly delaying refunds and, if so,  implement such a strategy for the 2012 filing season. Given these additional documentation  requirements already in place, we believe that the benefits of making  state assistance agreements available to adoptive parents on the IRS  website outweigh the risks.
Why GAO Did This Study

The federal adoption tax credit, established in 1996, was amended in 2010. These amendments included making the credit refundable (meaning taxpayers could receive payments in excess of their tax liability) and increasing the maximum allowable credit to $13,170 of qualified adoption expenses for tax year 2010. As of August 20, 2011, taxpayers filed just under 100,000 returns, claiming about $1.2 billion in adoption credits. Following these changes, the Internal Revenue Service (IRS) developed a strategy for processing adoption credit claims. GAO was asked to (1) describe IRS's strategy for ensuring compliance with the adoption credit for the 2011 filing season, (2) assess IRS's related communication with taxpayers and stakeholders, and (3) assess its processing and audit of claims. To conduct its analysis, GAO analyzed IRS data and documents, interviewed IRS officials, observed IRS examiners, and interviewed other stakeholders.

What GAO Found

IRS's strategy for ensuring taxpayer compliance with the adoption credit included the following: (1) Communicating and reaching out to taxpayers and other stakeholders, including tax professionals and adoption organizations, about new requirements. (2) Requiring taxpayers seeking the adoption credit to submit proof of a completed or in-progress adoption with their return. Because taxpayers claiming the credit for a special needs child (meaning that a state determined the child cannot or should not be returned to a parent, and using specified criteria, the state can reasonably assume that the child will not be adopted without state assistance) are allowed to claim the full credit without providing documentation of adoption expenses, they also needed to provide documentation certifying the special needs status of the child. (3) Requiring that returns and supporting documentation be filed on paper. (4) Automatically sending returns with missing or invalid documentation for correspondence audits (audits that IRS conducts by mail). To inform taxpayers, paid preparers and other stakeholders about new adoption credit requirements, IRS used various tools including its website, Twitter accounts, and YouTube recordings. However, IRS did not make a specific effort to communicate or convey information about documentation requirements for special needs children to state adoption managers, who administer state adoption programs. Further, IRS did not specify in training materials for its audit examiners what documentation was required to prove special needs status. IRS later revised its training materials to say that a state adoption assistance agreement (an agreement between the state and adoptive parents) was sufficient proof but did not provide samples of such agreements in the materials or place any on its website. As a consequence, taxpayers submitted a majority of returns with either no documentation or insufficient documentation. As of August 2011, 68 percent of the nearly 100,000 returns on which taxpayers claimed the adoption credit were sent to correspondence audit. However, of the approximately 35,000 returns on which audits have been completed as of August, IRS only assessed additional tax about 17 percent of the time. The equivalent rate for all correspondence audits in 2010 was 86 percent. The time it has taken IRS to audit these predominantly legitimate adoption credit claims has resulted in considerable delays in the payment of the related refunds. For the 2012 filing season, IRS has options that might allow it to reduce the number of costly audits and issue refunds faster while still maintaining a robust enforcement strategy. One option is for IRS to immediately send a letter to taxpayers who submit returns without any documentation requesting it before initiating an audit. This could potentially reduce the number of audits and delayed refunds, but IRS has not yet determined the extent of this impact. IRS officials acknowledged that data from the 2011 filing season experience should allow them to determine whether sending an initial letter requesting documentation would be more effective than initiating a correspondence audit.

What GAO Recommends

GAO recommends that IRS communicate with state and local adoption officials, provide examiners with examples of adoption assistance agreements, place the agreements on its website, and determine whether sending a letter before initiating an audit would reduce the need for audits. IRS generally agreed with three of GAO's recommendations, but had concerns that placing sample agreements on its website may enable fraud. However, since other proof of adoption must accompany a tax credit claim, GAO believes the benefits of making these agreements available to adoptive parents outweigh the risks.