Leslie Book is a contributing author with Tax Analysts through the Procedurally Taxing blog, which he co-founded in 2013. He is a professor of law at the Villanova University Charles Widger School of Law, a senior fellow at the Center for Taxpayer Rights, and the successor author for the treatise IRS Practice and Procedure, originally authored by Michael Saltzman.
In this article, Book examines the importance of the IRS's effective administration of refundable credits.
I read with interest Chandra Wallace’s article, "How Many EITCs Were Lost When IRS Destroyed 30 Million 1099s?" (Tax Notes Federal, Sept. 4, 2023, p. 1704). The article builds on the Treasury Inspector General for Tax Administration's 2022 report, which revealed that the IRS, buried under paper during the darkest days of the COVID-19 pandemic, expunged about 30 million information returns.
While on the surface this doesn't directly relate to the earned income tax credit, in his article “‘There Will Come Soft Rains’: Automation Amid Unprecedented Destruction” (Tax Notes Federal, Aug. 28, 2023, p. 1437), Justin Schwegel discusses the harms that flowed to taxpayers who faced correspondence audits when they claimed the EITC but whose post-expungement IRS records were no longer able to substantiate the earned income they needed to justify the credit.
Following the TIGTA report's release, Justin worked with an EITC-claiming client who faced an IRS audit about the income he reported on a Form 1099 that was one of the millions of expunged returns. Justin’s article paints a convincing case based on circumstantial evidence that his client's situation, and that of thousands of others, was probably an unintended consequence of the IRS's actions. The missing Forms 1099 likely triggered exam filters that led to many taxpayers facing an audit that wouldn't have happened if the IRS had processed and retained the documents.
There are some interesting lessons that we can learn from this situation. Justin’s article and advocacy highlight how the Freedom of Information Act can uncover serious problems with tax administration. This advocacy is even more important when the consequences of the IRS’s actions fall on mostly underrepresented taxpayers who may struggle to overcome or even respond to an audit. Those taxpayers are less likely to have the political voice to ensure that the government acts in a way that doesn't violate their interests or rights.
Moreover, this story shows how low-income taxpayer clinics like Gulfcoast Legal Services, where Justin works, and the Center for Taxpayer Rights, whose Tax Chat series highlighted Justin’s work, can shine a spotlight on issues that affect underrepresented and low-income taxpayers. People interested in the fair administration of tax laws should be grateful for their creative advocacy and persistence, as well as the wisdom of Congress and others supporting the work that these organizations perform. (Disclosure: I am on the board of the Center for Taxpayer Rights.)
What does all of this say about the IRS? The agency faces unique challenges when it comes to administering refundable credits like the EITC when eligibility often hinges on issues outside its knowledge. In addition to the difficulty that the IRS faces when it tries to understand the complexities of family life, the IRS struggles to understand the economic activities of taxpayers who are working outside of traditional W-2 employee status.
When it comes to the EITC and income issues, sometimes the IRS takes a view contrary to what it typically argues in audits — namely, that the taxpayer doesn't have the income necessary to justify the claimed credit. For an excellent discussion of one such case see Carl Smith’s 2015 post, "The Often Topsy-Turvy World of EITC Litigation."
We know from past studies that there are serious compliance issues with taxpayers who inflate or create income to justify or enhance an EITC. While some may disagree with IRS decisions about who is or is not audited, most agree that the IRS must audit some EITC-claiming taxpayers to ensure the program’s integrity.
Over the years I and others have suggested ways for the IRS to improve its correspondence compliance function to minimize the burdens on those who are audited. See, for example, "Exclusionary Effects of the IRS Correspondence Audit Process Warrant Further Study," a paper by Kathleen Bryant and Chye-Ching Huang on behalf of the NYU Tax Law Center, as well as me, Keith Fogg, and Nina Olson on behalf of the Center for Taxpayer Rights. The paper calls for, among other things, research into ways to make the process less burdensome and easier for taxpayers to engage with.
Nina, on behalf of the Center for Taxpayer Rights, also convened a series of workshops entitled "Reimagining Tax Administration: Running Social Programs Through the Tax Code." The series highlights the many challenges that taxpayers and the IRS alike face when Congress uses the tax system to deliver benefits and included a discussion about correspondence exams with Justin, Janet Holtzblatt, and Day Manoli. Nina also wrote about how to transform the IRS so it can excel in delivering benefits embedded in the tax system, including suggestions on how to change the culture of the IRS by creating a Family and Worker Benefit Unit, in a multi-part series for Procedurally Taxing. These issues will also be explored at the Center’s upcoming September 13th conference, "Transforming Tax Administration: Toward an Effective, Trusted & Inclusive IRS." The link to register, with both a virtual and in-person option, is here.
In the work Nina and others have done looking at the IRS's procedures for EITC audits, a common theme is the need to consider both the lives of those who are facing audit and the policy objectives underlying audit programs. That became even more crucial as countless Americans struggled during the pandemic and relied even more on the lifeline that tax-embedded benefits provided. If taxpayers face an audit because the IRS itself failed to process and retain information returns, and many of those taxpayers fail to receive or are forced to repay benefits they were entitled to receive, then the IRS will have failed to deliver the high quality of service that we should expect from it and that it aspires to deliver.
What could the IRS have done here? Perhaps it should have anticipated that expunging the Forms 1099 would have a downstream impact on EITC claimants. As Justin noted, the IRS should have suspended using a missing Form 1099 as an audit filter. Having failed to do so, the IRS could have created a soft notice process for those taxpayers rather than subject them to correspondence exams. At a minimum, it would have been helpful to issue guidance to make IRS employees and the public aware of the possibility that taxpayers claiming an EITC who received a Form 1099 may be questioned about proving their income due to the document destruction. That would have allowed advocates to assist in providing outreach to taxpayers about potential inquiries from the IRS about the existence or amount of income claimed on a return.
In thinking about refundable credits, I have come to appreciate that there are no silver bullets when it comes to the successful administration of family-based credits. When highlighting areas where the IRS falls short, the goal should be not to politicize those faults or to lay blame. Rather, the aim is to think more broadly about how the IRS can both minimize the risks of harming taxpayers and become an agency that embraces the reality that its actions are increasingly a part of the frayed safety net under some of our most vulnerable citizens.
As the IRS transforms itself following the generational funding that Inflation Reduction Act provided, a key metric for its success will be its administration of refundable credits. The story of the missing information returns and its impact on EITC audits reveals that the IRS has lots of room for improvement.