Objectives, Scope, and Methodology

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. Accordingly, we calculated confidence intervals at the 95 percent confidence level to indicate the precision of the estimates. To determine whether this $4.4 billion overclaim estimate is reasonably accurate, we evaluated IRS’ study methodology. 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. 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 Methodology Supported the Reported Findings

IRS’ study is representative of taxpayers filing an EIC claim on a tax year 1994 return filed between January 15 and April 21, 1995. Largest Source of EIC Overclaims for Tax Year 1994 Was Nonqualifying Children

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. 1. 3. Recent Compliance Efforts Are Aimed at Major Sources of Noncompliance, but It Is Too Early to Measure Their Effect

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. This choice generally should result in lower administrative costs and higher participation rates and emphasizes that the credit is for working taxpayers. 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. 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. 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. 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.
Why GAO Did This Study

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.

What GAO Found

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.