June 3, 2014

The Earned Income Tax Credit (EITC) provides a much-needed income boost to thousands, if not millions of hard-working men and women who earn low to moderate incomes. The payment amount for which taxpayers can qualify through the EITC  increases with family size.

For instance, a married couple with three or more children can qualify for the EITC with a combined gross annual income of as much as $52,427. A married couple with two children can qualify for the EITC with a combined gross annual income of up to $49,186. The credit is also generous; in 2013 the maximum credit was $6,143 for a family with three children and $5,460 for a family with two children.

In addition to lowering the federal income tax burden for those who qualify, the EITC is payable as a refund from the Internal Revenue Service to taxpayers who qualify for more in credits than they owe in federal income taxes. Since 2009, “census data indicate that the EITC credits and payments lifted 6.6 million individuals out of poverty in 2009, including more than 3 million children,” according to a report issued by the Center on Budget and Policy Priorities.

So it’s all good, right? Not quite. 

Extensive Overpayments Made

In spite of being one of the most effective federal programs designed to lift children out of poverty, the EITC has also been a particularly attractive target for attempted fraud. According to a recent report issued by the Treasury Inspector General for Tax Administration, the IRS overpaid approximately $11.6 billion to $13.6 billion in EITC credits during the 2012 fiscal year. This figure represents an astonishing 21 to 25 percent of all EITC payments made during that period.

Even more outrageous is the fact that the 2012 EITC overpayment figure represents one of the lowest proportions of overpayments recorded during the past decade. For instance, in 2003, overpayments accounted for as much as 30 percent of all EITC payments, costing the federal government $11.5 billion. In total, the IRS has overpaid as much as $132.6 billion in EITC distributions since 2003. Even more incredible – the figure could have been even higher. Inspector General J. Russell George estimated that the IRS successfully blocked more than $50 billion in fraudulent EITC refund claims on more than 15 million suspicious federal income tax returns just since 2011.

The 2010 Improper Payments Elimination and Recovery Act, designed to reduce unjustified payments, mandates that the IRS must reduce improper payments below a 10 percent threshold. The IRS has not yet established annual goals to meet this threshold, which is a violation of the Act. But there is little danger that the EITC will fall victim to partisan attempts to cut or eliminate the program, because it is widely acknowledged as a success on both sides of the aisle.

The Role of Shifting Demographics

Fraud (or attempted fraud) is not always the culprit behind EITC overpayments. The payment structure of the credit strongly favors married couples with children who live in the same household, which also accounts for many honest mistakes made by taxpayers, many of whom live in nontraditional families. Many errors occur in families where parents are divorced or separated, or when children are being raised by family figures or guardians other than their parents. 

In its report, the Treasury’s oversight office acknowledged that the IRS “faces significant and unique challenges” in preventing EITC overpayments. The combination of a rapidly changing demographic makeup to the population of families and individuals claiming the EITC and processing time limits for federal income tax returns make it nearly impossible for the IRS to verify every EITC claim before making payments. 

Reducing Future Overpayments

The report advises the establishment of “incremental reduction targets that can be used to evaluate the benefit of the IRS’s compliance and outreach efforts” as a first step to reducing overpayments made through the EITC program. Providing clearer explanations of the administration of the complex EITC to taxpayers from nontraditional families and to paid tax preparers could also significantly reduce the number of overpayments made due to honest errors.