The IRS runs various automated checks of certain data on a tax return before payment of a refund but is otherwise limited in its ability to question and correct the taxpayer’s claim. The IRS must deploy a variety of costly enforcement tools, including audits, to verify the information on the tax return and then prevent the payment of tax refunds or collect any tax due. As a result, the IRS allocates a disproportionate amount of its enforcement resources to audit returns that claim one or more RTCs. This creates several problems. Because lower-income taxpayers make up the majority of those claiming RTCs, they are subjected to a disproportionate number of audits (RTC claimants are audited at almost three times the rate of other taxpayers.) Since lower-income taxpayers make up a significant portion of taxpayers claiming RTCs, auditing these taxpayers can lead to a negative perception of IRS’s treatment of taxpayers. This runs counter to the IRS’s mission of fairness to all taxpayers.

Internal Revenue Service - American Opportunity Tax Credit has established a baseline.

The program's current year improper payment and unknown payment rate of 26.28 % has not been achieved with a balance of payment integrity risk and controls and does not represent the lowest rate that can be achieved without disproportionally increasing another risk, therefore it is not the tolerable rate.

Not applicable.

The IRS has internal controls in place to verify eligibility when data is available. Treasury and IRS analyses have consistently found that refundable tax credit (RTC) overclaims are largely attributable to the statutory design and complex eligibility requirements, and not rooted in internal control weaknesses, financial management deficiencies, or reporting failures. Therefore, the IRS works with Treasury to develop legislative proposals that will improve RTC compliance and reduce erroneous payments.

For FY 2021 , the Administration included the following proposals in its Budget submission:

Provide the IRS with greater flexibility to address correctable errors: This proposal would have expanded the instances in which the IRS could correct a taxpayer’s return including cases where: (1) the information provided by the taxpayer does not match the information contained in government databases or Form W-2, or from other third party databases as the Secretary of the Treasury determines by regulation; (2) the taxpayer has exceeded the lifetime limit for claiming a deduction or credit; or (3) the taxpayer has failed to include with his or her return certain documentation that is required to be included on or attached to the return. This proposal would make it easier for the IRS to correct obvious taxpayer errors, directly improving tax compliance and reducing EITC and other RTC overclaims.

Increase Oversight of Paid Tax Return Preparers: This proposal would have explicitly provided that the Secretary of the Treasury have the authority to regulate all paid tax return preparers. This would promote high-quality services from paid tax preparers, decrease collection costs, increase revenues, and increase confidence in the tax system.

For FY 2022 , the Administration again included in its Budget submission increased oversight of paid tax return preparers as a proposal, as well as the following additional proposal:

Increase penalties on ghost preparers: The proposal would increase the penalty amount to the greater of $500 per return or 100 percent of the income derived per return by a ghost preparer. The proposal would also increase the limitations period during which the penalty may be assessed from three years to six years. The proposal would be effective for returns required to be filed after December 31, 2021.

The IRS runs various automated checks of certain data on a tax return before payment of a refund but is otherwise limited in its ability to question and correct the taxpayer’s claim. The IRS must deploy a variety of costly enforcement tools, including audits, to verify the information on the tax return and then prevent the payment of tax refunds or collect any tax due. As a result, the IRS allocates a disproportionate amount of its enforcement resources to audit returns that claim one or more RTCs. This creates several problems. Because lower-income taxpayers make up the majority of those claiming RTCs, they are subjected to a disproportionate number of audits (RTC claimants are audited at almost three times the rate of other taxpayers.) Since lower-income taxpayers make up a significant portion of taxpayers claiming RTCs, auditing these taxpayers can lead to a negative perception of IRS’s treatment of taxpayers. This runs counter to the IRS’s mission of fairness to all taxpayers.

The IRS has internal controls in place to verify eligibility when data is available. Treasury and IRS analyses have consistently found that RTC overclaims are largely attributable to the statutory design and complex eligibility requirements, and not rooted in internal control weaknesses, financial management
deficiencies or reporting failures. The IRS has a strong internal control environment around refundable credit programs administered and makes decisions based on overall cost-benefit considerations. The IRS
annually reviews and enhances its refundable credits compliance plan that addresses erroneous claims. Therefore, legislative changes are the most effective means of addressing the causes of these improper payments.

Internal Revenue Service - American Opportunity Tax Credit has established a baseline.

The FY 2023 Estimated Improper Payment Rate is the same as the FY 2022 Improper Payment Rate. The unique nature of tax administration means that traditional target-setting as a means of approaching reductions in RTC improper payments will be ineffective. The RTC statute is such that IRS has limited authority to make changes to the claims during return processing. More so, most of the eligibility and credit determination requirements depends on factors that are not fundamentally known by the IRS at the time of filing. The IRS heavily relies on taxpayer-provided information without verifiability by third-party sources. The complexity of the law contributes to confusion around eligibility requirements and is one of the major contributing factors of improper payments. Error prevention and recoveries are achieved through time-consuming and resource-intensive examinations and other compliance activities. IRS does not have the resources to audit every return claiming RTCs, and the adjustments able to be attained through this process are small relative to the amount of improper payments estimated for the program. Without legislative change to greatly improve effective tools to administer these credits, the improper payment rate will not drastically change.

The program's current year improper payment and unknown payment rate of 36.08 % may or may not be the tolerable rate. The agency has not yet determined the tolerable rate for this program.

Treasury and IRS analyses have consistently found that refundable tax credit (RTC) overclaims are largely attributable to the statutory design and complex eligibility requirements, and not rooted in internal control weaknesses, financial management deficiencies, or reporting failures.

To reduce overclaim rates to less than 10 percent, to meet Payment Integrity Information Act (PIIA) compliance standards, the IRS estimated, in a Fiscal Year 2021 study, that it would need additional or reallocated resources of $2.5 billion to audit 4.2 million additional RTC returns in the pre-refund environment. If the IRS must reallocate enforcement resources to be compliant with PIIA, a substantial loss in enforcement revenue, estimated at $6.4 billion, would result because the IRS would divert resources from more valuable programs and tax gap elements to audits of RTC returns. Moreover, such enforcement actions would place substantial burden on low-income taxpayers through increased audits and delayed refunds, violating the IRS requirement of enforcing the tax law with integrity and fairness. As such, IRS has long held that focusing enforcement resources on the larger tax gap is a more efficient and
cost effective way to minimize the tax gap and maximize tax collections. We further support the reporting of RTC overclaims within the Tax Gap Analysis to reflect better how the IRS approaches taxpayer compliance relative to the U.S. tax system.

For FY 2023 , the Administration included the following proposals in its Budget submission:

(1) Increase Oversight of Paid Tax Return Preparers.
The proposal would amend Title 31, U.S. Code (Money and Finance) to provide the Secretary with explicit authority to regulate all paid preparers of Federal tax returns, including by establishing mandatory minimum competency standards.

(2) Expand and increase penalties for return preparation and e-filing –
The proposal would increase and expand the IRS’s authority to address noncompliance or inappropriate behavior by paid tax return preparers and e-file providers. First, it would increase the penalty amounts that apply to paid tax return preparers for willful, reckless or unreasonable understatements, as well as for forms of noncompliance that do not involve an understatement of tax. Second, the proposal would establish new penalties for the appropriation of Preparer Tax Identification Numbers (PTINs) and Electronic Filing Identification
Numbers (EFINs) and for failing to disclose the use of a paid tax return preparer. Third, the proposal would increase the limitations period during which the penalty for a failure to furnish the preparer’s identifying number may be assessed from three years to six years. Fourth, the proposal would clarify the
Secretary’s authority to regulate the conduct and suitability of persons who participate in the authorized e-file program, including setting standards and imposing sanctions to protect the integrity of the e-file program.

The annual Dependent Database (DDb) meetings, collaborations/data sharing with other federal agencies and outreach/education efforts are adequate measures because they will continue to aid the Service in mitigating the impact of the root causes. Much of the difficulty administering the American Opportunity Tax Credit (AOTC) derives from the complexity of its statutory eligibility requirements, many of which are known only to the taxpayer and cannot be independently confirmed using third-party corroborating data. Likewise, the primary root causes of improper payments of the AOTC are the inability to authenticate eligibility at return filing because the data needed does not exist, and taxpayer income misreporting related to self-employment income and other income where the income is not reported to the IRS by a third party. Nevertheless, the IRS has a strong and effective internal control environment around refundable tax credit programs and makes decisions based on overall cost-benefit considerations.

Internal Revenue Service - American Opportunity Tax Credit has established a baseline.

The FY 2024 estimated improper payment rate is the same as the FY 2023 improper payment rate. The unique nature of tax administration means that traditional target-setting as a means of approaching reductions in refundable tax credit (RTC) improper payments will be ineffective. The RTC statute is such that IRS has limited authority to make changes to the claims during return processing. More so, most of the eligibility and credit determination requirements depends on factors that are generally not known by the IRS at the time of filing. The IRS heavily relies on taxpayer provided information without verifiability by third-party sources. The complexity of the law contributes to confusion around eligibility requirements and is one of the major contributing factors to improper payments. Error prevention and recoveries are achieved through time-consuming and resource-intensive examinations and other compliance activities. IRS does not have the resources to audit every return claiming RTCs, and the adjustments able to be attained through this process are small relative to the amount of improper payments estimated for the program. Without legislative change to greatly improve effective tools to administer these credits, the improper payment rate will not change significantly.

The program's current year improper payment and unknown payment rate of 31.63 % may or may not be the tolerable rate. The agency has not yet determined the tolerable rate for this program.

Similar to the previous year, IRS has not yet determined a tolerable rate. Reducing the improper payment rate to less than 10 percent would require significant restructuring of the RTC programs, to include legislative action. Accordingly, the IRS does not have a current target date to report the tolerable rate.

The IRS has what is needed with respect to internal control, human capital and information system and other infrastructure to reduce American Opportunity Tax Credit (AOTC) Improper Payments and Unknown Payments to a tolerable rate. The issue with AOTC is statutory program design and reliance on taxpayer self-certification. The IRS has a strong internal control environment around AOTC and makes decisions based on overall cost-benefit considerations, with a well-trained, technically capable program staff.

The IRS is realigning resources internally to accelerate progress against its strategic priorities. The IRS will substantially be reducing the number of correspondence audits focused specifically on certain refundable credits, including the American Opportunity Tax Credit (AOTC). Focusing on helping taxpayers submit accurate filings upfront will increase payment accuracy while reducing administrative burdens for the IRS and the tax filer.

The challenge in administering refundable tax credits (RTCs) is that RTCs do not have the characteristics of a typical payment program. The fundamental root cause of RTC improper payments are as follows: (1) there is a statutory lack of a required pre-approval process; (2) an inability to wholesale deny payments (refunds) and (3) the information needed to verify taxpayer claims of eligibility belongs primarily to the taxpayer without any third-party data source available at the time of filing, thus requiring the IRS to rely on taxpayer self-certification that all return information is accurate. RTCs are managed within and follow the regulatory scheme of tax administration and enforcement. At a lower level, the root causes are that, at the time of filing/payment: (a) there is an inability to authenticate eligibility (typically due to a series of complex eligibility rules, many with relationship and residency tests containing with many nuances); (b) there are instances where taxpayer income is misreported, particularly related to self-employment income and other income not reported to the IRS by a third party; and (c) there is turnover of taxpayers who receive certain credits for the first time and fail to understand the complex requirements of claiming the credit. Pursuant to federal statute, the IRS generally does not have the capability to deny even incorrect claims, given the lack of math authority. However, the IRS's information technology platform includes a number of filters that the IRS uses to monitor the accuracy of compliance with eligibility rules and payment certification. The annual Dependent Database (DDb) meetings, collaborations/data sharing with other federal agencies, and outreach/education efforts aid the IRS in mitigating the impact of these root causes. Lastly, the IRS has a number of outreach and education programs in place, to help taxpayers and tax preparers understand the program eligibility rules and file accurate returns claiming RTCs.

The regulatory structure of refundable tax credits (RTCs), which lacks a pre-approval process and causes the IRS to rely heavily on taxpayer self-certification that their returns claiming RTCs are accurate, is a key factor contributing to RTC improper payments. Despite these constraints, the IRS has strategically designed corrective actions to address the root causes of improper payments by improving the accuracy of filed returns and mitigating the risks associated with taxpayer self-certification. The IRS has implemented a series of corrective actions focused on mitigating these root causes. The annual Dependent Database (DDb) meetings focus on reviewing and adjusting compliance filters used in audit selection, which allows the IRS to detect errors earlier. The IRS also cross-collaborates with the Department of Health and Human Services (HHS), the Social Security Administration (SSA) and the Office of Child Support Enforcement (OCSE) to share data that would enable the IRS to identify discrepancies in taxpayer claims. The IRS is re-aligning its efforts to further its strategic initiatives; accordingly, the IRS is investing in taxpayer outreach and education, in lieu of conducting additional pre-refund audits. By helping taxpayers file accurate returns upfront, quickly fixing errors that delay refunds and ensuring taxpayers claim the credits and deductions for which they are eligible, the IRS will correct payment accuracy issues without substantially increasing the burden on taxpayers and the IRS.

The primary challenge in administering refundable tax credits (RTCs), such as the American Opportunity Tax Credit (AOTC), is the complexity of the credits' statutory eligibility requirements. As a result, the key root causes of RTC improper payments are as follows: (1) the lack of a preapproval process and inability to authenticate eligibility at the point of return filing; (2) taxpayer misrepresentation or misunderstanding of key points of eligibility, especially for self-employment or other income not reported to the IRS by third-parties; and (3) the inability for the IRS to wholesale deny refunds. Because of these root causes, the IRS has to rely on taxpayer self-certification of an accurate return. The IRS has implemented a series of corrective actions focused on mitigating these root causes. The annual Dependent Database (DDb) meetings focus on reviewing and adjusting compliance filters used in audit selection, which allows the IRS to detect errors earlier. The IRS also cross-collaborates with the Department of Health and Human Services (HHS), the Social Security Administration (SSA) and the Office of Child Support Enforcement (OCSE) to share data that would enable the IRS to identify discrepancies in taxpayer claims. Finally, the IRS has invested in taxpayer education and outreach efforts, through such venues as the IRS's Nationwide Tax Forums and Latino Tax Fest, to educate tax preparers about their responsibilities to verify taxpayer eligibility before filing claims. The IRS is re-aligning its efforts to further its strategic initiatives; accordingly, the IRS is investing in taxpayer outreach and education, in lieu of conducting additional pre-refund audits. By helping taxpayers file accurate returns upfront, quickly fixing errors that delay refunds and ensuring taxpayers claim the credits and deductions for which they are eligible, the IRS will correct payment accuracy issues without substantially increasing the burden on taxpayers and the IRS. All of these corrective actions are strategically designed to address the root causes of improper payments by improving the accuracy of filed returns and mitigating the risks associated with taxpayer self-certification.

The regulatory structure of refundable tax credits (RTCs), which lacks a pre-approval process and causes the IRS to rely heavily on taxpayer self-certification that their returns claiming RTCs are accurate, is a key factor contributing to RTC improper payments. Despite these constraints, the IRS has strategically designed corrective actions to address the root causes of improper payments by improving the accuracy of filed returns and mitigating the risks associated with taxpayer self-certification. The IRS has implemented a series of corrective actions focused on mitigating these root causes. The IRS prioritizes its corrective actions based on the magnitude of the root causes they address and the potential impact of each action on reducing improper payments. Data-driven analyses are critical in determining which area gain focus. For example, the IRS is re-aligning its efforts to further its strategic initiatives; accordingly, the IRS is investing in taxpayer outreach and education, in lieu of conducting additional pre-refund audits. By helping taxpayers file accurate returns upfront, quickly fixing errors that delay refunds and ensuring taxpayers claim the credits and deductions for which they are eligible, the IRS will correct payment accuracy issues without substantially increasing the burden on taxpayers and the IRS. The IRS ensures that its corrective actions are continuously monitored, effectively implemented and reprioritized based on their ability to address the root causes of RTC improper payments.

Internal Revenue Service - American Opportunity Tax Credit has established a baseline.

The FY 2025 estimated improper payment rate is the same as the FY 2024 improper payment rate. The unique nature of tax administration means that traditional target-setting as a means of approaching reductions in refundable tax credit (RTC) improper payments will be ineffective. The RTC statute is such
that IRS has limited authority to make changes to the claims during return processing. More so, most of the eligibility and credit determination requirements depends on factors that are generally not known by the IRS at the time of filing. The IRS heavily relies on taxpayer provided information without verifiability
by third-party sources. The complexity of the law contributes to confusion around eligibility requirements and is one of the major contributing factors to improper payments. Error prevention and recoveries are achieved through time-consuming and resource-intensive examinations and other compliance activities. IRS does not have the resources to audit every return claiming RTCs, and the adjustments able to be attained through this process are small relative to the amount of improper payments estimated for the program. Without legislative change to greatly improve effective tools to administer these credits, the improper payment rate will not change significantly.

The program's current year improper payment and unknown payment rate of 27.65 % may or may not be the tolerable rate. The agency has not yet determined the tolerable rate for this program.

Similar to previous years, reporting a tolerable rate has not been determined for the American Opportunity Tax Credit. It is important to note the Refundable Tax Credits (RTCs) do not have the characteristics of a typical payment program. The primary root causes of improper payments of RTCs are the inability to authenticate eligibility at return filing because the data needed does not exist, and taxpayer income misreporting related to self-employment income and other income where the income is not reported to the IRS by a third party. Put simply, payment eligibility and certification decisions for RTCs are made by the taxpayer during the filing process.

Reducing the improper payment rate to less than 10 percent would require significant restructuring of the RTC programs, to include legislative action. Accordingly, the IRS does not have a current target date to report the tolerable rate.

The IRS has what is needed with respect to internal control, human capital and information system and other infrastructure to reduce Refundable Tax Credits (RTCs) Improper Payments and Unknown Payments to a tolerable rate. The issue with RTCs is statutory program design and reliance on taxpayer self-certification. The IRS has a strong internal control environment around RTCs and makes decisions based on overall cost-benefit considerations, with a well-trained, technically capable program staff whose tenure far exceeds that of other agencies. The Treasury Inspector General for Tax Administration (TIGTA) has traditionally reported that the issue with improper payments is not an internal control deficiency.

Reducing the improper payment rate to less than 10 percent would require significant restructuring of the RTC programs, to include legislative action.

Further improving the integrity of refundable tax credit (RTC) programs will take actions beyond our control. We have proposed various legislative changes over the years aimed at providing more effective tools for managing RTCs. For the FY 2025 budget submission, the Administration included the following proposals:

1. Expand and increase Penalties for Return Preparation and E-filing - The proposal would increase and expand the IRS’s authority to address noncompliance or inappropriate behavior by paid tax return preparers and e-file providers. First, it would increase the penalty amounts that apply to paid tax return preparers for willful, reckless or unreasonable understatements, as well as for forms of noncompliance that do not involve an understatement of tax. Second, the proposal would establish new penalties for the appropriation of Preparer Tax Identification Numbers (PTINs) and Electronic Filing Identification Numbers (EFINs) and for failing to disclose the use of a paid tax return preparer. Third, the proposal would increase the limitations period during which the penalty for a failure to furnish the preparer’s identifying number may be assessed from three years to six years. Fourth, the proposal would clarify the Secretary’s authority to regulate the conduct and suitability of persons who participate in the authorized e-file program, including setting standards and imposing sanctions to protect the integrity of the e-file program.

2. Increase Oversight of Paid Tax Return Preparers - The proposal would amend Title 31, U.S. Code (Money and Finance) to provide the Secretary with explicit authority to regulate all paid preparers of federal tax returns, including by establishing mandatory minimum competency standards.

These statutory changes may help reduce RTC errors to some degree. However, a meaningful reduction in the estimated error rate is unlikely without independent data sources through which the IRS can verify taxpayer-provided information and additional time and resources for the IRS to address any issues identified.