The Earned Income Tax Credit (EITC) is one of the largest sources of welfare benefits in the United States. In our current economic climate, the EITC has become even more important as families are struggling harder to make ends meet. For tax year 2011, a taxpayer with three or more children can qualify for up to $5,751 in EITC benefits; a taxpayer with two children, for up to $5,112; a taxpayer with one child, for up to $3,094; and a taxpayer with no children, for up to $464. Unlike other welfare benefits, where the recipient must apply and be approved, taxpayers claim the EITC by filing a tax return.
People who claim the EITC are subject to a high level of audits by the Internal Revenue Service (the Service) because of perceived noncompliance. A 2007 study by the National Taxpayer Advocate (NTA) indicates that fraud does not account for all EITC noncompliance. The NTA found that represented taxpayers were almost twice as likely to be found eligible for the EITC as compared to their unrepresented counterparts. This article explores how pro bono tax professionals can make a meaningful difference in the lives of low-income taxpayers.
Problems with the EITC. Even though the EITC rules seem straightforward, they confuse many taxpayers, leading some to not claim the credit. Another problem is noncompliance. To deter erroneous claims, the Service relies primarily on two tools: audits conducted on questionable claims and recertification requirements once a claim has been rejected. From the Service’s point of view, in addition to outright fraud, noncompliant claims include any claim where the taxpayer did not participate in the audit process or did not provide the appropriate documentation to substantiate the EITC claim.
Low-income taxpayers and the Service. To understand the noncompliance problem, we first need to consider some common attributes associated with a lack of resources that negatively affect many low-income taxpayers’ ability to navigate the audit process.
Finding and maintaining safe housing can be a major obstacle for many low-income taxpayers. This often means frequent moves and even periods spent in temporary housing situations or homelessness. High rates of mobility can affect a low-income taxpayer’s ability to begin and stay with the audit process until it is completed.
Low literacy rates are also an obstacle. This problem affects taxpayers’ ability to fully understand their rights and responsibilities and can make the EITC rules seem even more confusing for the taxpayer.
Low-income taxpayers, like taxpayers in general, are often wary of the government and the Service in particular. For an EITC audit, the Service asks taxpayers to supply personal information—including marriage and birth certificates, medical and school records—as well as financial records. Many taxpayers are wary about sharing this information. They are also nervous about what will happen if they pursue their case.
Adults living in poverty are four times more likely to report “serious psychological distress” compared to adults with income at least twice the poverty level. A taxpayer with severe anxiety or depression may struggle to simply open the mail, let alone participate in the EITC audit process.
The EITC audit process. The Service begins the audit by sending an initial letter to the taxpayer with a proposed assessment and an explanation for the audit. A form is generally enclosed with this initial contact, explaining the different documents that can be used to substantiate the EITC claim. If the taxpayer does not respond to the initial notice or sends insufficient documentation, the Service will issue a second notice, which comes with a 30-day deadline. If the second notice is not responded to, or is responded to insufficiently, the Service will issue the statutory notice of deficiency, providing the taxpayer with a chance to file a petition in Tax Court.
If a taxpayer fails to prove eligibility during an EITC audit, his or her account will be marked with an “indicator,” which prevents any future EITC claims until the taxpayer completes the recertification process. Recertification requires that the taxpayer file Form 8862 with subsequent tax returns. If there is any error on the form, the EITC will be disallowed.
Barriers for low-income taxpayers. The 2007 NTA study showed that represented taxpayers had greater success during the EITC audit process as compared to unrepresented taxpayers. It further looked at obstacles that exist for low-income taxpayers: communication, documentation, and process.
One would expect communication problems to flourish when the Service relies on correspondence to resolve tax problems with a population of people having high mobility and low literacy. A separate study by the NTA found that nearly 6 percent of taxpayers chosen for an EITC audit had their case closed because the initial notice was undeliverable. When the taxpayer receives the notice, the situation is even more serious. In the 2007 study, the NTA found that more than 25 percent of the taxpayers who received the initial notice did not know that they were being audited. Almost 40 percent did not understand what the Service was questioning.
During the course of a correspondence exam, the Service will request documentation from the taxpayer to substantiate the claim. This exchange of documents is the essence of the process; a taxpayer who cannot comply will not be successful in the audit. The NTA found that 60 percent of the taxpayers had a difficult time obtaining documents. Reasons included not being able to take time off work, not being able to find papers, not keeping records, not knowing what documents were required, not knowing where to get them, and not being able to pay for them.
The NTA found that 46 percent of taxpayers prefer telephone communication and 23 percent prefer face-to-face communication when it comes to resolving their tax issues. However, the majority of EITC audits are conducted by correspondence. To make matters worse, oftentimes the Service does not assign a particular worker to each case. This can make following up with a case time-consuming as taxpayers have to start from the beginning in subsequent phone calls to the Service.
Reliance on tax preparers. In 2008, 66 percent of returns with an EITC claim were prepared by paid preparers. It’s not surprising that a majority of taxpayers claiming the EITC rely on the assistance of paid preparers. Unfortunately, recent undercover visits by government personnel found that many unenrolled preparers did not ask the basic due diligence questions for taxpayers claiming the EITC. Since then, the Service has begun strengthening the regulation of paid tax return preparers in this area.
How pro bono professionals can help. First, tax professionals can bring their knowledge and experience. They can assure taxpayers that their case has merit and lay out a road map for the process. A professional can focus the taxpayer on the pertinent documents and offer time-saving advice, such as to not send original documents to the Service. Second, tax professionals can bring their advocacy skills. Tax professionals know which arguments to make and how to make them. Last, tax professionals can offer stability. By receiving information on behalf of taxpayers, a tax professional can improve the chances that taxpayers will complete the audit process even if they have to move during the time it takes to resolve the case.
ABA Section of Taxation
This article is an abridged and edited version of one that originally appeared on page 1 of Section of Taxation NewsQuarterly, Summer 2011 (30:4).
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