I am looking
at a report from the Treasury Inspector General for Tax Administration (TIGTA) dated
March 31, 2014 and carrying the non-hummable title of
The Internal Revenue Service Fiscal Year 2013 Improper Payment
Reporting Continues to Not Comply With the Improper Payments Elimination and
Recovery Act.”
We have
reviewed a number of previous TIGTA’a publications, and this one concerns the
earned income credit. The initial idea behind it was laudable enough: it was
intended to provide a floor to the most economically disadvantaged, while
simultaneously diluting the disincentive as someone weaned off welfare and went
back into the workforce.
Sounds good,
right?
There is a
card game called Magic: The Gathering. I have a number of friends who play, and
one in particular who is a Tournament judge. Think of Dungeons and Dragons,
translate it into a card game and you have Magic: The Gathering. The reason I
bring it up is that there is a Magic card that allows one to put a dragon onto
the board at no cost to the player. Dragons are as formidable as you would
expect, so this is not insignificant in game context. The friends refer to it
colloquially as “Dude, free dragon”!
The earned
credit is the tax Code version of “Dude, free dragon”!
This credit
was virtually built to be abused, and abused it has always been and will always
be. One cannot turn down free dragons.
What does it
take to power the earned income tax credit? It takes two things: earned income
and a dependent child.
· Earned income means that you have paid social
security or self-employment tax on it. Workers compensation or unemployment,
for example, will not power the EITC as one does not pay social security on either.
· The other thing you need is a kid.
Two is better than one. Three is better than two. Four is no better than three,
so there is a limit to this escalation.
NOTE: There is a very limited credit for someone with little
income and no children, but we will set that category aside for this
discussion.
You need to
have a job. Makes sense, if you remember what I said earlier about removing
disincentives to return to work. A W-2 job is the easiest to understand.
Self-employment
income will also do it. I suspect that any tax practitioner who has been around
the block a few times has had or heard of an EITC client reporting self-employment
income, likely with few if any expenses. The taxpayer is incentivized to
lowball his/her expenses, as the credit can outstrip any additional taxes due from
overstating his/her actual income. Alternatively, one might simply “make up”
income, just to power the EITC.
You also need
a kid. This is where it gets problematic, especially nowadays. It can take the discipline of a sociologist
to follow the convoluted trail of who-did-what-and-then-moved-in-with…. The
bottom line is that a kid is the key to this ride. Having a kid, especially a
kid you can “lend” out, becomes a commodity, and, like any commodity, the kid has
value.
Where does a
tax pro see this? Easy. How about two unmarried people who have a child
together. One brings a child from a prior marriage. The facts make more sense
if they maintain two households, but they wouldn’t be the first to live
together and have two EITCs sent to the same address.
OBSERVATION: I am giving the IRS this one for free: check for
two EITCs sent to the same address. You are welcome.
So you come
to see me. You tell me that you are taking care of your on-and-off-girlfriend’s
second daughter, because her mother is irresponsible and you have taken a
liking to the girl. You are thinking of adopting, immediately after that
around-the-world flight on a paraglider you are planning. Coincidentally the kid also gives you an
earned income tax credit. How am I to know whether this is really taking place,
whether that the child is living with you and not with her mother, yada yada
yada?
I will tell
you what the IRS has said I am to do. Then I will tell you what I actually do.
The IRS
keeps expanding what a tax preparer is to do when faced with an earned income
tax credit. Let’s go back to the
Improper Payments Information Act that TIGTA referenced. This law goes back to
2002. TIGTA goes on to explain:
… the IRS’s estimates of Fiscal Year 2012 improper EITC
payments were understated. They were based on an assumption that a provision in
the American Recovery and Reinvestment Act of 2009 … that increased the EITC
for certain taxpayers would expire at the end of 2010. However, the Tax Relief,
Unemployment Insurance Reauthorization and Job Creation Act of 2010 extended
the provision through 2012.”
Did you get
that? The IRS did not update its 2012 estimates
for a law passed in 2010. Amazing.
Let a tax CPA do that and he/she will soon have no clients.
Let’s
continue:
It was later extended through December 2017 by the American Taxpayer Relief Act of 2012.”
There is my
second freebie to the IRS.
The EITC remains the only revenue program fund to be
considered at high risk for improper payments.”
How much
money are we talking about?
The IRS estimates that 22% to 26% of EITC payments were
issued improperly in Fiscal Year 2013. The dollar value … was estimated to be
between $13.3 billion and $15.6 billion.”
This is real
money, even by Washington standards. So what was the IRS plan to deal with
this?
The IRS announced a plan in January 2010 to register, license
and create enforcement tools that would impact the paid preparer community more
broadly.
Paid preparers assisted in the preparation of approximately
66 percent of all EITC claims paid in Tax Year 2008.”
Let me see
if I get this right:
· The IRS has a “Dude, free dragon” tax
credit
· People abuse “Dude, free dragon”
· A normal person can hardly prepare
his/her own taxes anymore, so he/she uses a preparer, therefore
· Abuse of the EITC is the preparer’s
fault
Right….
Let’s
continue.
However, in January 18, 2013, a Federal Court enjoined the
IRS from enforcing the regulatory requirements for registered tax return preparers.”
We discussed
this in an earlier blog. The IRS was arguing that they could regulate preparers
because of a Treasury decision having to do with government payment for horses
after the civil war. The Federal Court said no; the IRS did not have legal authority
and could not arrogate such authority to itself.
NOTE: Seems quaint reasoning, especially after six years of
the current Administration, doesn’t it?
The IRS is
miffed, sticks out its lip and pouts:
The Court ruling materially affects the basis on which the
IRS planned to establish a baseline for meaningful reduction targets as
previously indicated.”
So IRS
Commissioner Koskinen is placing blame on the tax preparer community. If only
the IRS could regulate preparers!
There is
some truth to this. There are many grades of preparers. There are the classically-trained,
such as tax attorneys and tax CPAs. There are also Enrolled Agents (EAs), many
of which are quite good. Then we drop to people who have taken an H&R Block
course. Then you have those that never even took the course. It is that last category
or two that the IRS wants to reach, but they have been stymied.
In the
meanwhile, you come into my office with an EITC. What does the IRS expect me to
do?
Remember
that the key is the kid. The IRS wants me to:
· Review school records
· Review health care records
· Review child care provider records
· Review social services records
And so on.
If I don’t do this, I have to indicate to the IRS that I did not do so. On a
form included with your tax return. The IRS reserves the right to later come to
my office and review my files.
As much as I
appreciate the opportunity to soothe my inner social worker, it seems a lot to
ask for the few hundred dollars I may charge for that tax return.
So what do I
do?
Easy. I do not
accept a client with an EITC. Furthermore, I would also consider releasing an existing
client who slips into the EITC, unless I know them well and have very strong
confidence in their tax numbers. I have to, as the risk to me from that tax
return is disproportionate.
I cannot afford to play “Dude, free dragon”!
