A nonrefundable credit can be used to offset tax liability, but any  excess of the credit over the tax liability is not refunded to the taxpayer. This  report focuses on the design and administration of the other three  refundable tax credits available to individuals. A qualifying child must meet certain age,  relationship, and residency requirements. In 2013, taxpayers claimed a total  of $68.1 billion in EITC with $59 billion (87 percent) of this amount  refunded; the total was $55.1 billion for the CTC and ACTC with $26.7  billion (48 percent) refunded as ACTC and a total of $17.8 billion in AOTC  with $5 billion refunded (28 percent). Lack of Third Party Data and Filing and Refund Deadlines Complicate IRS’s Enforcement Efforts

Lack of third party data complicates IRS’s ability to administer these  credits, but such data are not easy to identify. Developing a Comprehensive Strategy for RTC Compliance Efforts and Greater Use of Available Data Could Help IRS Better Target Limited Enforcement Resources

		IRS’s Lack of a Comprehensive Compliance Strategy for RTCs Hampers Its Ability to Make Informed Resource Allocation Decisions

Sustained annual budget reductions at IRS have heightened the  importance of determining how best to allocate declining resources to  ensure it can still meet agency-wide strategic goals of increasing taxpayer  compliance, using resources more efficiently, and minimizing taxpayer  burden. The average yearly amount  overclaimed for the EITC was $18.1 billion, for the CTC/ACTC was $6.4  billion, and for the AOTC was $5.0 billion. IRS  officials observed an increase in the ACTC overclaim percentage from  2009 to 2011. IRS Is Missing Opportunities to Use Available Data to Identify Drivers of ACTC and AOTC Noncompliance

IRS does not track the number of returns erroneously claiming the ACTC  and AOTC identified through screening activities. There is some evidence that PEPS may be a useful tool for detecting  noncompliance. Conclusions

Each year the EITC, ACTC, and AOTC help millions of taxpayers—many  of whom are low-income—who are working, raising children, and paying  tuition. IRS is working on a strategy to document current EITC  compliance efforts and identify and evaluate potential new solutions to  address improper payments, but this review does not include the other  refundable credits. IRS is also missing opportunities to use available data to identify potential  sources of noncompliance and develop strategies for addressing them. Structural  changes to the credits, such as changes to eligibility rules, will involve  trade-offs with respect to standard tax reform criteria, such as  effectiveness, efficiency, equity, simplicity, and revenue adequacy. Take necessary steps to ensure the reliability of collections data and  periodically review that data to (a) compute a collections rate for post- refund enforcement activities and (b) determine what additional  analyses would provide useful information about compliance results  and costs of post-refund audits and document-matching reviews. However,  we found that a significant amount of enforcement activity is occurring in  the post-refund environment. We recognize that gathering collections data has costs and the data have  limitations, notably that not all recommended taxes are collected. However, use of these data— once IRS is able to verify its reliability –  could better inform resource allocation decisions and improve the overall  efficiency of enforcement efforts. GAO staff members who made major contributions to this report  are listed in appendix V.

Appendix I: Objectives, Scope, and Methodology

This report (1) describes the claimant population including the number of  taxpayers and the amount they claim along with other selected  characteristics for the Earned Income Tax Credit (EITC), Additional Child  Tax Credit (ACTC), and American Opportunity Tax Credit ( AOTC); (2)  describes how the Internal Revenue Service (IRS) administers these  credits and what is known about the administrative costs and compliance  burden associated with each credit; (3) assesses the extent to which IRS  identifies and addresses noncompliance with these credits and collects  improperly refunded credits; and (4) assesses the impact of selected  proposed changes to elements of the EITC, ACTC, and AOTC with  respect to three criteria for a good tax system: efficiency, equity, and  simplicity. Appendix III: Research Findings on the Current Refundable Tax Credits

The following is a summary of the findings in the policy literature of the  effect of the current design of the Earned Income Tax Credit (EITC), the  Additional Child Tax Credit (ACTC), and the American Opportunity Tax  Credit (AOTC) on the effectiveness, efficiency, equity, and simplicity of  these credits.
Why GAO Did This Study

Refundable tax credits are policy tools available to encourage certain behavior, such as entering the workforce or attending college. GAO was asked to review the design and administration of three large RTCs (the EITC, AOTC, and ACTC). The ACTC is sometimes combined with its nonrefundable counterpart, the Child Tax Credit. For this report GAO described RTC claimants and how IRS administers the RTCs. GAO also assessed the extent to which IRS addresses RTC noncompliance and reviewed proposed changes to the RTCs.
GAO reviewed and analyzed IRS data, forms and instructions for claiming the credits, and planning and performance documents. GAO also interviewed IRS officials, tax preparers, and other subject-matter experts.

What GAO Found

The Earned Income Tax Credit (EITC), the Additional Child Tax Credit (ACTC), and the American Opportunity Tax Credit (AOTC) provide tax benefits to millions of taxpayers—many of whom are low-income—who are working, raising children, or pursuing higher education. These credits are refundable in that, in addition to offsetting tax liability, any excess credit over the tax liability is refunded to the taxpayer. In 2013, the most recent year available, taxpayers claimed $68.1 billion of the EITC, $55.1 billion of the CTC/ACTC, and $17.8 billion of the AOTC.
Eligibility rules for refundable tax credits (RTCs) contribute to compliance burden for taxpayers and administrative costs for the Internal Revenue Service (IRS). These rules are often complex because they must address complicated family relationships and residency arrangements to determine who is a qualifying child. Compliance with the rules is also difficult for IRS to verify due to the lack of available third party data. The relatively high overclaim error rates for these credits (as shown below) are a result, in part, of this complexity. The average dollar amounts overclaimed per year for 2009 to 2011, the most recent years available, are $18.1 billion for the EITC, $6.4 billion for the CTC/ACTC, and $5.0 billion for the AOTC.
IRS uses audits and automated filters to detect errors before a refund is sent, and it uses education campaigns and other methods to address RTC noncompliance. IRS is working on a strategy to address EITC noncompliance but this strategy does not include the other RTCs. Without a comprehensive compliance strategy that includes all RTCs, IRS may be limited in its ability to assess and improve resource allocations. A lack of reliable collections data also hampers IRS's ability to assess allocation decisions. IRS is also missing opportunities to use available data to identify potential noncompliance. For example, tracking the number of returns erroneously claiming the ACTC and AOTC and evaluating the usefulness of certain third party data on educational institutions could help IRS identify common errors and detect noncompliance.
Proposals to change the design of RTCs--such as changing eligibility rules--will involve trade-offs in effectiveness, efficiency, equity, and simplicity.

What GAO Recommends

GAO recommends 1) IRS develop a comprehensive compliance strategy that includes all RTCs, 2) use available data to identify potential sources of noncompliance, 3) ensure reliability of collections data and use them to inform allocation decisions, and 4) assess usefulness of third-party data to detect AOTC noncompliance. IRS agreed with three of GAO's recommendations, but raised concerns about cost of studying collections data for post-refund enforcement activities. GAO recognizes that gathering collections data has costs. However, a significant amount of enforcement activity is occurring in the post-refund environment and use of these data could better inform resource allocation decisions and improve the overall efficiency of enforcement efforts.