The earned income tax credit is supposed to be a boon for low-income families like Natassia Smick's. But, as she's found, claiming the credit often prompts a grueling, slow-moving review by the IRS. (photo: Kendrick Brinson/ProPublica)
13 December 18
If you claim the earned income tax credit, whose average recipient makes less than $20,000 a year, you’re more likely to face IRS scrutiny than someone making twenty times as much. How a benefit for the working poor was turned against them.
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Natassia Smick, 28, filed her family’s taxes in January, she already
had plans for the refund she and her husband expected to receive.
Mainly, she wanted to catch up on her credit card debt. And she was
pregnant with their second child, so there were plenty of extra expenses
ahead.
Since Smick, who is taking classes toward a bachelor’s
degree, and her husband, a chef, together earned around $33,000 in
2017, about $2,000 of that refund would come from the earned income tax
credit. It’s among the government’s largest anti-poverty programs,
sending more than $60 billion every year to families like Smick’s:
people who have jobs but are struggling to get by. Last year, 28 million
households claimed the EITC.
Smick, who lives outside Los Angeles, thought she’d
get her refund in a month or so, as she had the year before. But no
refund came. Instead, she got a letter from the IRS saying it was
“conducting a thorough review” of her return. She didn’t need to do
anything, it said. Smick waited as patiently as she could. She called
the IRS and was told to wait some more.
It wasn’t until four months later, in July, that she
got her next letter. The IRS informed her that she was being audited.
She had 30 days to provide “supporting documentation” for basically
everything. As she understood it, she needed to prove that she and her
husband had earned what they’d earned and that her child was her child.
By this point, Smick was home with her baby. She set
about rounding up W-2s, paycheck stubs, bank statements and birth
certificates. Proving that her 4-year-old had lived at the family’s
address for most of the year, as the EITC requires, was the hardest
thing, but she did her best with medical records, some papers from his
day care, and whatever else she could think of.
She sent it all off and hoped for a quick resolution, but the next IRS letter
quashed that hope. The IRS said it would review her response by Feb.
16, 2019 — six months away. Collectors were calling about the credit
card bills. She didn’t know how she’d make it that long.
Smick couldn’t understand why this was happening. All
she had done was answer the questions on TurboTax. Isn’t it rich people
who get audited? “We have nothing,” she said, “and it’s just frustrating
knowing that we have nothing.”
It seemed there was nothing she could do. And when she
called the IRS to ask how it could possibly take so long to review her
documents, she remembers being told that there was nothing they could do, either: The IRS was “extremely short staffed,” the person said.
Budget cuts have crippled the IRS over the past eight
years. Enforcement staff has dropped by a third. But while the number of
audits has fallen across the board, the impact has been different for
the rich and poor. For wealthy taxpayers, the story has been rosy: Not only has the audit rate been cut in half, but audits now tend to be less thorough.
It’s a different story for people who receive the
EITC: The audit rate has fallen less steeply and the experience of being
audited has become more punishing. Because of a 2015 law, EITC
recipients are now more likely to have their refund held, something that
can be calamitous for someone living month-to-month.
IRS computers choose people to audit, but if those
taxpayers respond, a person must review the documents. With fewer
employees to do that, delays have mounted in a process that was already
arduous, according to several attorneys who represent taxpayers through
the Low Income Taxpayer Clinic program. It regularly takes more than a
year to get a taxpayer’s refund released, they said, even for those who
are represented.
“If the service doesn’t have the personnel to evaluate
evidence submitted in a timely manner, then they should not be
initiating the exams in the first place,” said Mandi Matlock, an
attorney with Texas RioGrande Legal Aid.
Generally, the more money you make, the more likely
you are to be audited. EITC recipients, whose typical annual income is
under $20,000, have long been the major exception. That’s because many
people claim the credit in error, and, under consistent pressure from
Republicans in Congress to curtail those overpayments, the IRS has kept
the audit rate higher. Meanwhile, there hasn’t been similar pressure to
address more costly problem areas, like tax evasion by business owners.
The budget cuts and staff losses have made this
distortion starker. The richest taxpayers are still audited at higher
rates than the poorest, but the gap is closing.
“What happens is you have people at the very top being
prioritized and people at the very bottom being prioritized, and
everyone else is sort of squeezed out,” said John Dalrymple, who retired
last year as deputy commissioner of the IRS. In 2017, EITC recipients
were audited at twice the rate of taxpayers with income between $200,000
and $500,000. Only households with income above $1 million were
examined at significantly higher rates.
Put another way, as the IRS has dwindled in size and
capability, audits of the poor have accounted for more of what it does.
Last year, the IRS audited 381,000 recipients of the EITC. That was 36
percent of all audits the IRS conducted, up from 33 percent in 2011,
when the budget cuts began.
“Those struggling to make ends meet are being unfairly
audited while the fortunate few dodge taxes without consequence,” Sen.
Ron Wyden, D-Ore., the ranking member on the Senate Finance Committee,
told ProPublica. “The IRS needs more manpower to go after tax cheats of
all sizes, and working Americans need a simpler way of obtaining a tax
credit they’ve earned.”
The IRS declined to answer questions about its EITC audits.
The EITC has bipartisan roots. Conceived as a “work
bonus” for low-income wage earners in the 1970’s and an alternative to
welfare, the program has grown over the decades
with the support of Republicans and Democrats. These days, the average
credit is for about $2,500, but for larger families, the amount can
exceed $6,000. The Census Bureau recently estimated that the EITC and
the child tax credit together boost millions of children out of poverty every year, more than any other government program.
Unlike Social Security or food stamps, the EITC has no
application process. Instead, taxpayers simply claim the credit on
their tax returns. Millions of people get it wrong in both directions,
according to IRS estimates. About a fifth of eligible taxpayers don’t seek the EITC. And almost a quarter of the $74 billion paid out this year was issued “improperly.”
That estimate of “improper payments,” about $17 billion, is the reason the EITC is such a focus for the IRS. Some tax experts — including the Taxpayer Advocate Service, an independent office within the IRS — argue the estimate is way too high.
One reason is that it is based on the outcome of audits, and low-income
taxpayers are much less likely to have competent representation to
dispute the IRS’ conclusions.
Regardless of the precise error rate, the IRS
acknowledges the primary cause of the problem is not fraud: It is the
law itself. It is too complex, too easy for someone to think themselves
eligible when they are not. The same child might be a “dependent,” for
example, but not a “qualifying child” under the EITC, and the IRS’ instructions for claiming the credit run to 41 pages.
“My third-year law students, they sit down and study
this material, and sometimes they still don’t get it,” said Michelle
Lyon Drumbl, a professor at Washington and Lee School of Law.
Since the 1990s, Republicans in Congress have focused on these improper payments as a major problem and harshly criticized the IRS
for failing to stop them. In 2015, the Republican Congress passed, and
President Barack Obama signed, a bill that required the IRS to hold EITC
refunds until Feb. 15 each year. The purpose was to give the IRS more
time to match tax returns with the corresponding W-2s to avoid
misstatements of income. But it also meant people who are audited are
more likely to see their refund held — instead of receiving the credit
and then undergoing audit. That’s a crucial difference for low-income
taxpayers.
“You expect this money during tax season and you don’t
get it… It tears you down,” said Paul McCaw, a forklift operator in
Rock Island, Illinois. He had refunds held for several years in a row
because the IRS doubted that his niece’s three young children lived with
him. For years, the family struggled. Bills piled up and eviction was a
constant threat. Finally, this year, with the help of a legal aid
attorney at Prairie State Legal Services, Macaw, 50, was able to
convince the IRS to release the refunds.
“I was just beside myself,” he said of finally getting
his refunds, adding, “I caught everything all up, and I also paid a
month in advance.”
Stopping faulty refunds from going out, rather than
trying to recoup them through an audit is “always the better option”
because it is more effective, said Jesse Solis, a spokesperson for House
Ways and Means Committee chair Kevin Brady, R-Texas.
Congress should
continue to look for ways to reduce improper payments, he said.
Taxpayers of all kinds cheat. And IRS studies have
found that EITC recipients aren’t close to the worst offenders. For
certain kinds of business income, for instance, people pay only about 37 percent of the tax they owe
because they simply don’t report the income. Hundreds of billions of
dollars in government revenue is lost. But people who have their own
businesses are audited at about the same rate as EITC recipients.
The IRS’ disproportionate focus on stopping EITC
“improper payments” is misguided, said Nina Olson, the national taxpayer
advocate. “What’s the difference between an erroneous EITC dollar being
sent out and a dollar attributed to unreported self-employment income
not collected?” she asked. Unreported business income is “where the real
money is,” she said.
When EITC cheating does occur, the culprits are
usually tax preparers, said Chi Chi Wu of the National Consumer Law
Center. “They know the system, they game the system and ultimately the
taxpayer ends up on the hook if there’s an audit,” she said.
In
undercover investigations by the NCLC and the Government Accountability Office, multiple preparers advised taxpayers to file bogus EITC claims.
About 60 percent of taxpayers use a preparer, but in
most states, preparers are not required to be licensed, and the IRS’
ability to oversee them is limited. After the agency launched a program
to certify preparers and subject them to regular compliance checks, a
federal appeals court ruled in 2014 that the IRS doesn’t have that
power. Congress could pass a bill to confer such authority on the
agency, but it has not done so, despite some bipartisan support for the
idea.
The IRS has a difficult task in auditing taxpayers who
claim the EITC. Low-income families are often complicated; they’re more
likely to be multi-generational than more affluent filers, for
instance, or to add or subtract household members from year to year. A
study by the nonpartisan Tax Policy Center found that only about 48 percent of low-income households with children were married couples, while for other households it was 75 percent.
But advocates for taxpayers say the IRS makes the
situation needlessly worse. Virtually all the EITC audits are conducted
by correspondence, and the computer-generated letters are far from
simple. A survey by the Taxpayer Advocate Service found that more than a
quarter of EITC recipients who were audited didn’t even understand that they were under audit.
“When I first got audited, I couldn’t figure out what
was going on,” said Denise Canady, 62, of West Memphis, Arkansas, who at
the time was earning $8.50 an hour as a home health aide. The audit
sent her on a scramble to get documents from her granddaughter’s doctor,
pharmacy, hospital and school that would demonstrate that the toddler
had lived at her address. “A lot of people don’t want to give you old
records,” she said.
She eventually found her way to Legal Aid of Arkansas,
where an attorney helped bolster her case, but, a year after her audit
began, she is still awaiting the outcome.
“I pray and hope,” she said.
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