Professor Book Presents at Loyola (LA) on Taxpayer Rights, Social Psychology, and the EITC

Les is out on the West Coast today presenting at Loyola Law School’s Tax Policy Colloquium.  Les is the first presenter this year, and the other speakers cover a broad range of topics.  Les’ talk is based on research and a paper he is currently working on, some of which is based on his prior writing and a number of Procedurally Taxing posts where he discusses the EITC, compliance, and criticism of the IRS in relying on sanctions like the Section 32(k) ban.   He also weaves in his interest in viewing these issues through the social science and behavioral economics lenses.

Some of Les’ recent PT posts that he pulls from for the talk and paper are:

Legislative Language Directs IRS to Make Self-Prepared EITC Claims More Burdensome

Warren Buffet Calls For Expanding EITC: Tax Administration Impact Highlights There is No Free Lunch

IRS Issues New Report on EITC Overclaims (Title A)

H&R Block CEO Asks IRS To Make it Harder to Self-Prepare Tax Returns and Why That is Good for the Tax System

The paper will likely not be finalized until later this fall, but the abstract for the paper and talk is as follows:

Thinking About Taxpayer Rights and Social Psychology to Improve Administration of the EITC


The IRS is a reluctant but key player in delivering social benefits to the nation’s working poor.  The earned income tax credit (EITC) is generally praised for its role in reducing poverty and incentivizing low-wage work. While the EITC has generally received bipartisan support, the IRS faces strong criticism over EITC compliance issues. Opponents focus on headline-generating reports of improper payments and a characterization of errors as likely due to fraud. Advocates look to the intersection of legal complexity and the characteristics of recipients as the main driver of error and the relatively low share of the tax gap that is attributable to refundable credits in general and the EITC in particular.

The current compliance challenge presents an opportunity to think about the compliance problem differently than before. In prior research, building off the work of sociologists Kidder and McEwen, I applied a typology of noncompliance to EITC claimants. That typology suggests that the problem of EITC overclaims is not a single problem but best thought of as many different compliance problems, some of which reflect intentional taxpayer misconduct and others which reflect problems that are more directly connected to the characteristics of the claimants (such as transiency or literacy challenges), perceived unfairness of eligibility rules, or actions attributable to third parties, such as return preparers who play an important role in the delivery of the EITC. In this article, I build on that typology by integrating recent compliance studies, current research on the increased complexity of American family life and two approaches that may present an opportunity for the IRS to improve the likelihood that claimants will voluntarily comply. One approach is based on research that suggests tax agencies can enhance voluntary compliance by an appropriate mix of power and measures that will enhance greater trust in the IRS. The other is based on social psychology research that has shown that by increasing psychological costs and the perceived likelihood of detection through changes in forms, disclosure statements and a more personalized communication approach people may be more inclined to be truthful in the first instance.

By explicitly tying in how possible administrative and legislative solutions relate to the complex structure of today’s American family life, trust in the tax administration, and social psychology research, this article takes the small but I believe important step of recognizing that IRS and Congress cannot principally rely on detecting and deterring noncompliance through audits, penalties and expanded summary tax return adjustment powers. While there is no silver bullet that Congress and IRS can turn to, and audits and penalties are and should remain an important part of a tax agency’s approach, the article provides insights from tax compliance researchers and offers specific administrative and legislative proposals that may improve administration of the EITC.


DOJ Cracking Down on Preparers Using its Injunction Powers and Requiring Preparer to Disgorge Illicit Profits

The government has lots of tools at its disposal when it comes to going after the effects of crooked preparers. Last week I wrote about how the fraud of a preparer can have consequences for the taxpayer and indefinitely extend a taxpayer’s SOL on assessment.   DOJ often goes after the illicit preparer as well, sometimes using its vast civil remedies, including injunctions, as Keith discussed in Return Preparer Shenanigans.

This past month the DOJ has been busy releasing information trumpeting its efforts to get civil injunctions against prepares as well as requiring those preparers to disgorge their profits. Preparers that submit returns with phony refundable credits seem to be getting a great deal of attention.


For example, last week the DOJ press release Federal Court Bars Florida Man from Preparing Tax Returns for Others and Enters $1 Million Disgorgement Judgment discusses how a district court in Florida entered an injunction and disgorgement order stemming from the facts as alleged below:

In September 2014, the United States filed a civil injunction complaint against Pierre-Louis alleging that he and his employees prepared fraudulent tax returns for customers.  The complaint alleged that return preparers in Pierre-Louis’s business targeted primarily low- to moderate-income customers with deceptive and misleading advertisements; prepared and filed fraudulent tax returns to increase their customers’ refunds; and profited through unconscionable, exorbitant and often undisclosed fees—all at the expense of their customers and the U.S. Treasury.  According to the complaint, Pierre-Louis and his employees prepared federal tax returns on which they falsely claimed earned income and education credits, reported improper filing statuses, concocted phony businesses, claimed bogus income and expenses related to the non-existent businesses and fabricated job-related expenses.  The complaint also named Jehoakim Victor and Lauri Rodriguez, allegedly former managers at Pierre-Louis’s tax preparation stores, as defendants.  In February 2015, the court permanently enjoined Victor and Rodriguez from preparing tax returns for others and from owning or operating a tax return preparation business.  Victor and Rodriguez agreed to entry of the injunction without admitting the allegations in the complaint.

The order itself is interesting and details just how far-reaching the government’s powers reach under those provisions, enjoining the preparer from preparing or assisting in preparing returns for others and essentially prohibiting him from having any commercial activity related to the preparation of tax returns, including getting a PTIN or EFIN.

The order also requires the preparer to turn over the identities of all people whose returns were prepared by the defendant and his related businesses, all the employees of the defendant and the related entities and also prohibits the defendant from selling any customer list. That customer list can lead to the issue I discussed last week, as it is likely that the IRS will systematically go after those individuals whose returns were prepared by this preparer.

In addition to the injunction, the order requires the defendant to cough up $1 million as a “for the disgorgement of the proceeds that Kerny Pierre-Louis received for the preparation of tax returns making or reporting false or fraudulent claims, deductions, credits, income, expenses, or other information resulting in the understatement of taxes.”

I have not focused much on the government’s use of general disgorgement powers to go after preparers. Disgorgement is an equitable remedy that has its roots in undoing enrichment rather than punishing and is meant to force the preparer to return profits from the improper activity. That disgorgement is not punitive may have significant consequences as to the deductibility of any such payments, as discussed in this McGuire Woods blog post discussing how the IRS in Field Service Advice opined that a Food and Drug Administration disgorgement order was not a non deductible fine or penalty under Section 162(f).

I have seen a number of disgorgement orders in return preparer cases recently and I suspect that they are now part and parcel of the government’s tool kit.

Some Observations

I am in DC this week attending a summit that the Commissioner has convened on the Earned Income Tax Credit. I have been interested in the EITC, and its administration, for years, starting with my time as a director of a low income taxpayer clinic.  I saw early on in my time as director claimants who used a return preparer that was either incompetent or unscrupulous, or both. Assigning blame between claimants or preparers and getting at the root cause of the source of the incorrect claim is a tricky business, and there have been very few meaningful qualitative studies that identify the extent of demand (claimant) or supply (preparer) driven noncompliance. As I have written previously, there is an interesting and complex relationship between preparers and claimants, and government efforts both before the fact (though regulation and oversight, including due diligence) and after the fact (including injunctions and preparer penalties, both civil and criminal) attempt to change the dynamics in that relationship.

In the blog and in other articles I have written about the various ways that the government has sough to change this dynamic. I am working on a longer paper that looks at compliance issues in some more detail. Most of what Congress has done in this area over the past decade has been to increase penalties and allow IRS to detect and unwind erroneous credits through the use of a more automatic reportable error that dispenses with traditional deficiency procedures(though IRS wants even more of that power). I am interested in learning from others at the summit, as this is a problem that is in need of solutions from many differing perspectives, not just increasing penalties and removing barriers to assessment.

UPDATE 7/1 After initially posting I learned that IRS last month has issued a CCA that held that certain disgorgement payments made to the Securities and Exchange Commission for violating the Foreign Corrupt Practices Act were not deductible. There is a lot of commentary on that substantive issue. For example, see Lawrence Hill from Shearman in the FCPA Report.

TIGTA Report Makes (Incomplete) Case For Expanded Math Error Authority

An earlier version of this post appeared on the Forbes PT site on May 20, 2016

TIGTA just released a report called Without Expanded Error Correction Authority, Billions of Dollars in Identified Potentially Erroneous Earned Income Credit Claims Will Continue to Go Unaddressed Each Year. The report is sure to generate headlines, as it details some eye popping numbers about EITC improper payment rate and the IRS’s failure to take action on EITC-claiming returns it knows are likely to contain errors. On the surface TIGTA makes a compelling case but I do not understand why the default solution TIGTA proposes is one that effectively treats EITC claiming individuals as a suspect class that is not entitled to the same due process protections as other individuals who file income tax returns. Our tax system is built on individuals having procedural protections in the form of pre-assessment Tax Court review rights through deficiency procedures. TIGTA’s proposals amount to a possible rejection of protections for millions of individuals least likely to be in a position to protect themselves against IRS overreaching.


A snapshot of the numbers from the TIGTA report shows that the improper payment rate hovering between 23 and 27% for the past six years, with 2015 estimates looking at about IRS improperly paying out $15.6 billion out of a total $62.3 billion claimed for a 24% improper payment rate. TIGTA also notes that the IRS has identified millions of EITC returns which it believes are likely erroneous but due to resource constraints (and perhaps other reasons) IRS fails to take action and prevent the outflow of improper credits. For example, for 2014 TIGTA estimates that IRS identified over 5.7 million EITC returns with over $20 billion claimed that were likely containing improper claims but due to resource issues IRS only “systematically corrected” about 166,000 of the returns:

We continue to report that IRS compliance resources are limited. Consequently, the IRS does not address the majority of potentially erroneous EITC claims despite having established processes that identify billions of dollars in potentially erroneous EITC payments. For example, the IRS identified approximately 5.7 million potentially erroneous EITC claims totaling approximately $20.7 billion in Tax Year 2014 for which it does not have error correction authority to address.

The TIGTA solution is one that the President has proposed in recent budget proposals, an expanded ability to use summary math error assessment procedures to disallow the credits without allowing people the same pre-assessment right to notice and Tax Court review that everyone else enjoys.

It has been a couple of years since I have discussed TIGTA math error proposals, but the TIGTA discussion brings to mind a post from December 2014 Annual TIGTA Review of IRS Erroneous Payments and The Possible Expansion of Math Error Powers. In that post I go into some more detail regarding the efficiency issues that the government points to in making the case for expanded math error procedures (it is on the surface way cheaper to use math error powers than to give taxpayers a stat notice and full blown deficiency rights). Back in 2014 I referred to TIGTA’s dollars and cents discussion:

While the IRS has the authority to audit potentially erroneous EITC claims for which it does not have math error authority, doing so is more costly than the math error process. The IRS estimates that it costs $1.50 to resolve an erroneous EITC claim using math error authority compared to $278 to conduct a prerefund audit. In addition, the number of potentially erroneous EITC claims the IRS can audit is further reduced by its need to allocate its limited resources among the various segments of taxpayer noncompliance to provide a balanced tax enforcement program. As a result, billions of dollars in potentially erroneous EITC claims go unaddressed each year.

The TIGTA report both now and in 2014 fails however to address some of the criticism of the proposals for expanded powers. In my 2014 post I argued for caution in this area:

If the administration is successful in getting its expanded summary assessment procedures, I hope that IRS carefully studies its impact (as it seems to have done with child support data), establishes clear guidelines for employees, and drafts simple understandable correspondence to allow taxpayers to unwind the assessment and get back in line for deficiency procedures. Some lower-income taxpayers may be less equipped to contest erroneous assessments; telephone wait times are long, and taxpayers who are lower-income are often more transient and less likely to receive correspondence. Add to the mix language and literacy obstacles and you have a potential recipe for real harm.

Congress’ continued use of the Internal Revenue Code to deliver social benefits combined with pressure on IRS to reduce error rates may lead to the IRS taking additional compliance steps without an ability to serve taxpayers who may be inadvertently caught in the compliance crosshairs. Even an agency intent on balancing competing interests must reflect the budget realities that are likely going to jeopardize those taxpayers least likely to be able to withstand erroneous IRS determinations.

In the 2015 NTA Report to Congress a section called Authorize the IRS to Summarily Assess Math and “Correctable” Errors Only in Appropriate Circumstances makes a systematic case for at least some more caution in this area before giving IRS expanded math error powers. That report suggests that before giving IRS expanded powers the following must take place:

  1. There is a mismatch between the return and unquestionably reliable data (rather than the IRS’s estimate about the mere probability of an error).
  2. The IRS’s math error notice clearly describes the discrepancy and how taxpayers may contest the proposed change.
  3. The IRS has researched all of the information in its possession (e.g., information provided on prior- year returns) that could reconcile the apparent discrepancy.
  4. The IRS does not have to analyze facts and circumstances or weigh the adequacy of information submitted by the taxpayer (e.g., whether sufficient documentation is attached) to determine if the return contains an error.
  5. The abatement rate for a particular issue or type of inconsistency is below a specified threshold for those taxpayers who respond.
  1. For any new data or criteria, the Department of Treasury, in conjunction with the National Taxpayer Advocate, has evaluated and publicly reported to Congress on the reliability of the data or criteria for purposes of assessing tax using math error procedures The report should analyze the burdens and benefits of the proposed use of math error authority, considering downstream costs
    to taxpayers (e.g., time, paperwork, representation) and the IRS (e.g., processing taxpayer calls and letters, requests for audit reconsideration, amended returns, appeals, and TAS intervention).

Parting Thoughts

I recognize that there is a compelling interest in reducing error rates for programs such as the EITC. Underlying the NTA suggestion for caution is that with expanded math error powers comes the distinct likelihood that millions of Americans who may claim the credit are the same Americans who need the procedural protections that come with the regular right to Tax Court pre-assessment review. Due process at its core reflects a balancing of interests between the government and its legitimate right to ensuring program integrity and the general right to protect against erroneous government determinations that deprive people of protected property rights. The NTA proposal to carefully study and consider the effect of expanded math error powers reflects a respect for the individual.  Congress has increasingly given IRS special powers when it comes to trying to nudge down the improper payment rate for the EITC. Congress would be well-served from stepping back and rather than continuing to add piecemeal provisions study individual noncompliance more generally and consider what is likely to work and what are the full consequences of additional IRS powers.


Summary Opinions Catch Up Part II

Second part of the catch up.  These materials are largely from February.  One more installment coming shortly.  We may be renaming SumOp.  Although I loved the name (thanks Prof. Grewal), this keeps getting linked as a summary of all Tax Court summary opinions.  Feel free to suggest names, although it may just fall under the Grab Bag title from now on.  And, if you work at a law firm that is taxed as a C-corporation, check out the Brinks, Gibson discussion below.  Might be a little scary.


  • Most of you probably heard that the Form 8971 was issued for basis reporting in estates.  Form can be found here and instructions here.  First set will (probably, although it has been extended a couple times already) be due June 30th.  Pretty good summary can be found here.  Lots of complaints so far.
  • The Fourth Circuit had a recent Chapter 7 priority case in Stubbs & Perdue, PA v. Angell (In re Anderson).  In Stubbs (great name), S&P were lawyers who represented Mr. Anderson.  Initially, the case was a Chapter 11 case, and S&P racked up $200k in legal fees.  Priority, but unsecured.  There was also over $1MM in secured tax debt.  The bankruptcy converted to a Chapter 7, and S&P were tossed in with the unsecured debtors, which they took exception with.  The Court looked to the current version of section 724(b)(2) of the bankruptcy code.  That section allows certain unsecured creditors to “step into the shoes” of secured creditors, and recover before other creditors.  Due to perceived abuses, that section had been amended in 2010 to limit the expenses that were given super priority, including Chapter 11 administrative expenses when the case was converted to a Chapter 7 case.  The amended provision was in place when the conversion occurred, and the Fourth Circuit relied on that version of the law, disallowing the legal fees super priority.  The law firm argued the prior version of the statute should apply, as it was the applicable statute when the originally filing occurred, but the Fourth did not agree.  Why does this really matter? It is the federal tax liability supported by the federal tax lien that gets subordinated to pay these priority claims.  So, the fight in this insolvent estate boiled down to whether the lawyers, who may have waited too long to convert the case to Chapter 7, or the IRS get paid (of course, the decision to convert is a client decision which puts the lawyer’s ability to get their fees at the mercy of the rationality of the client’s decision. A bad place to be) (thanks to Keith for giving me a quick primer on this subject).
  • The Tax Court in Brinks, Gilson & Lione, PC v. Commissioner has probably caused quite a bit of concern for quite a few law firms – or should (which reminds me, I have something to discuss with the Gawthrop management committee).  McGuire Woods has a good write up, and some insight into planning around the issue, which is found here.  The facts are that the firm would provide partners with a salary, and then at year end it would take all the profits and provide year-end bonuses to the partners, who would treat the amounts as W-2 wages.  This would wipe out the profits, so the c-corporation law firm would have no tax due (sounds familiar to a lot of you in private practice, doesn’t it?).  This firm had close to 300 non-lawyer employees who generated profits, and the IRS said that treating the bonus amount as w-2 income on to the partners on what those other folks generated was improper.  The corporation should have paid tax, and then dividends should have been issued to the partners, who would also then pay tax.  Yikes!  That is interesting enough, but the Court also found that the firm lacked substantial authority for its positions and there was no reasonable cause under Section 6662(d)(2)(B), so substantial penalties were also due on the corporate income tax due (the regulations do not allow for an “everyone else is doing it” defense).
  • Sometimes you go into court just knowing you are going to look like an @s$ for one reason or another.  I may have felt that way walking in to argue Estate of Stuller for the government before the Seventh Circuit.  Not because I would have been wrong, but, based on the opinion, the taxpayer was having a pretty bad year.  In Stuller, the Court held that the penalties for failure to timely file returns were proper when a restaurant business owner (who was a widow) missed the filing deadline.  In the year in question, the husband died in a tragic fire, which also injured the widow.  In addition, a key employee was embezzling from her businesses and she had difficulty tracking down aspects of the probate proceedings.  The Court found all required info could have been found in her records, and she did not exercise ordinary business care and prudence to fulfill the requirements of the reasonable cause exception (it probably didn’t help that she was taking questionable deductions related to her “horse” business that lost like $1.5MM in the preceding years).
  • We have covered Rand pretty extensively here on the blog, including the reversal of it by section 209 of the PATH Act and the Chief Counsel advice that followed, which can be found here.    In February, additional guidance was released stating there are no longer any situations where the Section 6676 penalty is subject to deficiency procedures, which was the same conclusion our (guest) blogger, Carlton Smith, came to in his post discussing the Kahanyshyn case.  Carl, however, reflected upon this more, and concluded there may, in fact, be a situation where the deficiency procedures might apply to a Section 6676 penalty.  I’m somewhat quoting Carl (via email) here.  All intelligent comments are Carl’s, while any errors are assuredly mine:

If you recall from prior posts, in PMTA 2012-016…the IRS changed its position and held that where it had frozen the refund of a refundable credit, there was no “underpayment” for purposes of section 6664(a) because the freezing of the refund should be considered as “an amount so shown [on the tax return] previously assessed (or collection without assessment)” under section 6664(a)(1)(B). So, there can be no assessment of a section 6662 or 6663 penalty in that circumstance.

However, section 6676′s penalty on excessive refund claims can apply even if the refund is never paid. Accordingly, within the PMTA, the IRS states (I think correctly) that where it freezes a refund of a disallowed refundable tax credit, it can assert a section 6676 penalty instead.

The PATH Act did two significant things to section 6676: It removed the previous exception to applying the penalty with respect to EITC claims. It changed the defense to the penalty from the troublesome proof of “reasonable basis” (an objective test) to the easier “reasonable cause” (a subjective one).

So, we may see section 6676 assessments in the future where refundable credits were improperly claimed, but the refund was frozen.…If a taxpayer improperly claimed, say, an EITC, but the refund was frozen, the IRS would later issue a notice of deficiency to permanently disallow the EITC.  The IRS could also assess a section 6676 penalty (assuming no reasonable cause), since it is the claiming of an improper refund that triggers the section 6676 penalty, not its payment.

It is still an open question whether or not the section 6676 penalty on disallowed frozen refundable credit claims will be asserted by the deficiency procedures or the straight-to-assessment procedures usually involved in the assessable penalties part of the Code.

  • In United States v. Smith, the District Court for the Western District of Washington reviewed a community spouse’s argument that her portion of the community property house could not be used to satisfy her husband’s tax debt from his fraud.  I found this write up of the case from a law firm out west, Miles Stockbridge.  The Court upheld the foreclosure, finding the wife did not show that she was entitled to the exception of collecting against community property under Section 66(c), nor did she show that the debt was not a community property debt by clear and convincing evidence, as required under Washington law.
  • Nothing too novel in US v. Wallis, from the District Court of the Western District of Virginia in February of 2016, but a good review of suspension provisions to collection statute.  In Wallis, the Service  took collection actions after the ten year period found under Section 6502 for penalties under Section 6722.  The Court found collection was not prohibited, as the statute was tolled due to the taxpayer’s bankruptcy and OIC/CDP hearings.  Sorry, couldn’t find a free version.
  • The folks over at The Simple Dollar have asked that we provide you with links to some of their content.  This post is about the best tax software for nonprofessionals to use for doing their own taxes.  This site is geared to the general public, but has some basic finance and tax info.  These are usually in the form of listicles, which are completely click bait, but are hard to hate.





Using Craigslist to Fish For Bogus Dependents

In today’s post I will highlight a recent post from my and Keith’s longtime colleague at Villanova, Jim Maule, on his eclectic blog Mauled Again. Jim’s post from earlier this week is called Buying and Selling Dependency Exemptions For Tax Purposes. In it he discusses a recent indictment detailing how a Missouri man advertised on Craigslist to buy phony dependents. From the DOJ Press Release (which as I do cautions that the information in the release reflects allegations), here is what the man posted on Craigslist in January of 2015:


The Missouri man got what he asked for and e-filed his 2014 return using those three kids, with the added chutzpah of filing by snail mail the 2012 and 2013 years to allegedly goose his refund. The Craigslist poster now is facing federal charges of filing false tax returns.


In addition to this just being newsworthy because of the way that the person publicly advertised his willingness to commit a felony (generating an honorable mention PT Darwin Award nomination), the actions highlight some of the challenges associated with using the tax system as a means to generate benefits based on family status. Jim uses the story to highlight his earlier proposal in a 1995 Tax Notes article, Tax and Marriage: Unhitching the Horse and Carriage, where he proposed to allow a system based on transferable exemptions so individuals say with little earned income could in fact sell the exemptions to those who could benefit. I copy from Jim’s post and his original article:

This unused exemption amount sale aspect of the proposal is not as mercenary as it initially appears. If unused exemption amounts could not be sold, then tax revenues, or budget deficits, would need to be increased to provide funds for public welfare programs benefitting the impoverished. Permitting impoverished individuals to sell unused exemption amounts transfers to those persons directly the dollars that would otherwise be collected by the federal government and transported through a bureaucratic maze that would reduce the amount reaching those in need by some substantial percentage. In a sense, it would create a ‘private market negative income tax.’

To the extent a negative income tax is unattractive because it involves cash grants from the government, the shifting of its incidence to the private sector eliminates direct governmental involvement and casts the exemption sale transactions in a private enterprise light. Though the negative income tax, even in the form of unused exemption amount sales, is considered by some to be a work disincentive, the amount for which the unused exemption amount could be sold would be less than the amount needed for anything more than bare subsistence and would not deter the ambitious or the proud from seeking employment.

Precedent for the sale of governmental benefits can be found in the transfer system permitting businesses to sell or transfer sulfur dioxide pollution allowances. In terms of the policy of permitting transfers, the unused exemption amount is essentially the same as the pollution allowance, because a person without the need for it can sell it to someone who does have such a need. [footnotes omitted]

The issues Jim raises suggest a possible less radical solution, which would be to allow custodial parents to share the benefit of an EITC with a noncustodial parent, along the lines suggested by Professor Mary Pareja at University of New Mexico Law in her article EITC Portability: Respecting the Autonomy of American Families. To be sure, from the release it is not clear if the Missouri man used the kids just for dependency exemptions or also the EITC, which would be harder to get through given its relationship requirement. Nonetheless, the temptation to improperly share kids with those who could benefit is enhanced when the tax system may not reflect the fluid living arrangements that many working poor face.

One of the other interesting parts of the Craigslist story is that there is a prosecution in the first place. Many years ago I researched states’ approaches to welfare fraud, and I was mildly surprised at how many states vigorously prosecuted food stamp and other benefits’ crimes as compared to the paucity of federal prosecutions for lower-income taxpayer abuse. Apart from federal prosecutions directed at preparers, there have been few prosecutions of individuals themselves who have [ab]used the tax system to generate undeserving refunds.

As Congress seems intent on using the tax system to deliver direct benefits to families, and also possibly expanding the EITC to subsidize childless workers, I believe it is important to reflect the administrative realties associated with using the tax system to deliver benefits. Interestingly, a possible expansion of childless EITC will greatly reduce the temptation to share kids, as well as the related sense of unfairness that many low-wage workers feels is connected to the current system which provides an all or nothing approach to some tax benefits based on arbitrary lines of physical attachment.

Tax Court Opinion in Ballard Highlights Fundamental Uncertainty of Its Jurisdiction to Rule on the IRS Power to Ban Taxpayers From Claiming Refundable Credits

There are a few procedural provisions in the Code that are specially targeted to refundable credit claims. One is Section 32(k). Under Section 32(k), there is a two-year ban (a disallowance period) for a claim “for which there was a final determination” that the claim was due to a reckless or intentional disregard of rules or regulations (the ban is ten years if the there is a final determination of fraud). Congress imported this ban from non-tax benefits’ programs like food stamps, originally limiting it to earned income tax credit (EITC) but last year expanding its reach to include child tax credit and American Opportunity Tax Credit claims.

This past week in Ballard v Commissioner, a bench opinion in a small tax case, the Tax Court questioned its jurisdiction relating to the imposition of the two-year ban under Section 32(k). The issue of the court’s jurisdiction is one we have raised before and while Ballard is nonprecedential, the court and IRS alike will have to face the issues in future disputes.


IRS audited Ballard and for good measure slapped an accuracy-related penalty and a two-year ban based on his recklessly claiming the EITC. The ban purported to preclude Ballard from claiming the EITC in 2014 and 2015.

In the bench opinion, the court found that Ballard was not entitled to treat the child as a qualifying child for purposes of the EITC or the CTC (though was able to treat him as a dependent) but was not subject to the accuracy-related penalty in part due to his use of a paid preparer and its finding that “nothing in the record suggested petitioner has any particular training or background in accounting or matters involving Federal income taxation.”

What caught my attention was the court’s discussion of the Tax Court’s jurisdiction to consider the ban in the current proceeding:

Respondent made that determination for the year in dispute here [2013], but the determination obviously has no consequence to the deficiency determined in the notice – the consequences of the determination take effect in years other than the year before us. Normally, in a deficiency case the Court is reluctant to make findings or rulings that have no tax consequences in the period or periods presently before it.

I have previously written that there is significant uncertainty as to how someone subject to a two or ten-year ban for recklessly or fraudulently claiming the EITC can challenge that determination in a deficiency proceeding. See Recent Tax Court Case Shows Challenges Administering Civil Penalties and the EITC Ban. The basic issue concerns whether in a deficiency proceeding the Tax Court has jurisdiction to effectively impose a potential penalty for a year that is separate from the year in which a taxpayer has filed a petition. As I discussed in my earlier post, “I do not believe the Tax Court has adequately explained how it can have jurisdiction over the merits of the ban relating to future years when there is no proposed deficiency for those future years. The Tax Court has previously side-stepped this issue, ….[a]nd it is likely that the 32(k) issues will continue to vex the Court until the IRS establishes the process, separate from the exam process, by which it makes the state of mind determination so central to 32(k)’s required findings.”

In another post, The Ban on Claiming the EITC: A Problematic Penalty, I elaborated:

The Tax Court is a court of limited jurisdiction. Section 6214(a) generally provides that the Tax Court has jurisdiction to redetermine the correct amount of the deficiency. Section 6214(b) provides in relevant part that the Tax Court in redetermining the correct amount of a deficiency for any taxable year “shall consider such facts with relation to taxes for other years…as may be necessary correctly to redetermine the amount of such deficiency, but in so doing shall have no jurisdiction to determine whether or not the tax for any other year…has been overpaid or underpaid.”

Carl Smith in the Problematic Penalty post offered his views as well:

Section 32(k) is not described as a penalty or addition to tax.  But, even if section 32(k) is a penalty, it is not contained within Chapter 68 dealing with additional amounts and penalties (Code secs. 6651-6751).  Section 6665 authorizes the deficiency procedures to apply to certain penalties imposed by Chapter 68, but that does not give the Tax Court jurisdiction to treat a section 32(k) determination as if it were a penalty imposed by Chapter 68.  Finally, there is no provision in the Code giving the Tax Court independent declaratory jurisdiction to review the IRS determination that 32(k) will apply to any EITC claim made in a later year.

As I describe in my prior posts, there are only two nonprecedential summary opinions where the Tax Court has discussed the merits of a ban, Baker v Commissioner and Garcia v Commissioner (I discuss Baker here and Garcia here). In both those cases there was no discussion of the jurisdictional issue Ballard raises. Ballard states that only nonprecedential cases exist on the issue though it also acknowledges the attractiveness as a policy matter of having the Tax Court decide the merits of the ban even though it may be outside its jurisdiction, a point I also made in my Problematic Penalty post, excerpted below:

Delaying the possibility of court review to a ban year places additional potential burdens on the court and taxpayers. Memories fade as time passes; it is harder to get documents that may be relevant, and witnesses may be less available. In addition, the uncertainty in outcome might chill lower-income taxpayers from claiming the EITC in a ban year, as the return will carry not only possible preparation costs but also the certainty that the EITC will be disallowed, triggering eligibility costs such as time and even legal fees (though most taxpayers will likely be pro se or represented by clinics, give the costs of representation relative to the amount in controversy). Moreover, the language that I have seen the IRS use in its correspondence in the conduct year suggests to taxpayers that they are prevented from even claiming the EITC in a ban year, which in and of itself may chill taxpayers from filing a return and getting the court review the IRS’s determination.

Ballard also highlights some practical problems with the ban:

In this case not only does the application of section 32(k) have no tax consequence to Petitioner’s Federal income tax liability for the year before us, the record does not reveal whether a finding or ruling on the point would have any Federal tax consequence in either 2014 or 2015. We cannot tell whether petitioner’s Federal income tax returns, if required, have been filed for those years– and point out that his return for 2015 is not yet even due. Assuming that one or both of those returns have been filed, we cannot determine if either return includes a Claim for an earned income credit.

In light of the above, in Ballard the court declined to rule on the ban though it did note that its finding that the accuracy-related penalties did not apply “strongly suggests” that the ban is not warranted.

Parting Thoughts

This opinion and my prior posts highlight the uncertainty surrounding the way an individual can challenge the IRS’s proposed ban under Section 32(k). Congress did not help in late 2015 by adding that the Child Tax Credit and American Opportunity Tax Credit can be subject to the ban and also cutting back further on taxpayer rights by allowing IRS to use math error procedures to disallow a credit that is claimed in the ban period. So, as Congress expands the credits potentially subject to the ban and also reduces taxpayer rights during the time the ban is in place (see my post Extenders Bill Gives IRS Additional Powers to Impose Penalties on Preparers and Disallow Refundable Credits on the 2015 legislative change), the Tax Court in Ballard highlights the possible limits on a taxpayer’s rights to get court review.

Ballard addresses the oddity that even if the ban is properly imposed a claimant would not potentially have notice of it until after he or she could file the return in later years. That also raises all sorts of fairness and potentially even due process issues. The ban itself is blunt; it may be of no effect anyway because in later years the claimant may not have been eligible to treat the child as a qualifying child (though with possible expansion of the childless EITC in the works it is possible that the impact could still be felt). At the same time, the ban may reach others who are not even parties to the dispute. Consider if someone who is subjected to the ban marries during the period that the ban is in effect. At that point it appears the taint of the ban reaches the spouse (with impact also potentially felt on minors who might now be eligible to be treated as qualifying children), as the EITC is not eligible to be claimed on MFS returns.


State of the Union: Tax Administration a Small But Important Part of the Speech

Tax procedure and administration are generally not on the radar in Presidential State of the Union addresses. Yet in this week’s State of the Union the President implicated both when he spoke about offshore evasion and expanding tax benefits for childless workers.

In this post, I will connect the dots from the speech and offer some thoughts about both offshore evasion and compliance issues relating to lower-income taxpayers.


President Obama’s State of the Union revolved around four main questions, including his first question:

How do we give everyone a fair shot at opportunity and security in this new economy? [the other questions dealt with technology, security and partisan rancor]

In discussing opportunities in the new economy, the President addressed some broad trends that have contributed to greater inequality and concentration of wealth, including how technology and the mobility of capital can contribute to job disruption. President Obama reached across the aisle to Speaker Ryan and noted his interest in tackling poverty and that he’d “welcome a serious discussion about strategies we can all support, like expanding tax cuts for low-income workers without kids.”

In an effort to frame the discussion away from blaming the poor, the President assigned some blame to those at the top of the income pyramid:

But after years of record corporate profits, working families won’t get more opportunity or bigger paychecks by letting big banks or big oil or hedge funds make their own rules at the expense of everyone else; or by allowing attacks on collective bargaining to go unanswered. Food Stamp recipients didn’t cause the financial crisis; recklessness on Wall Street did. Immigrants aren’t the reason wages haven’t gone up enough; those decisions are made in the boardrooms that too often put quarterly earnings over long-term returns. It’s sure not the average family watching tonight that avoids paying taxes through offshore accounts.

Offshore Evasion

Offshore evasion is one of the biggest issues in tax administration of the past decade. While we have discussed offshore evasion only occasionally, it has been covered heavily by others, including one of our blogging inspirations, Jack Townsend at Federal Tax Crimes.

I recently read an interesting article on offshore evasion by Professor Cass Sunstein in the New York Review of Books, called Parking the Big Money. The article reviewed Professor Gabriel Zucman’s The Hidden Wealth of Nations: The Scourge of Tax Havens as well as a film called The Price We Pay. Zucman’s book takes a crack at putting a price tag on offshore evasion, using an approach that compares the world’s liabilities to the world’s assets, noting that “as far back as statistics go, there is a ‘hole’; if we look at the world balance sheet, more financial assets are recorded as liabilities than as assets, as if planet Earth were in part held by Mars.”

Sunstein continues:

In 2015, for example, the nations of the world reported $2 trillion as mutual fund holdings in Luxembourg; this is the total of recorded liabilities. But Luxembourg’s own statisticians calculated that worldwide, $3.5 trillion in mutual fund holdings were kept in Luxembourg; that is the total of recorded assets. What happened to the missing $1.5 trillion? In global statistics, that amount had no owners. For Zucman’s purposes, the anomaly is a revealing one: the amount by which assets exceed liabilities is a measure of wealth hidden in offshore accounts.

Using some detective skills, Zucman estimates that the effects of offshore evasion are severe, with the cost annually at $200 billion in lost revenues, with the US out about $35 billion.  Zucman’s proposal to address the problem is a far-reaching international registry of ownership, though he is a big fan of our own FATCA and that law’s requirement that foreign banks identify their US clients and disclose them to the IRS.

At around the same time I read the Sunstein review, I also received via email a report by the American Citizens Abroad that was based on a survey it and researchers at the University of Nevada Reno conducted on Americans abroad.  The survey revealed how overseas Americans believe FATCA should be reformed to address some of its negative consequences. Those consequences include some overseas financial institutions no longer dealing with Americans and among those that still do, higher costs of doing business.

FATCA, as Sunstein notes, is a blunt tool and to the Americans abroad who are complying or who are small fish, the law imposes heavy costs.  But as the State of the Union reflects, there should be little sympathy for Americans who stash cash and the like in tax havens. Given the extent of the problem that Zucman via Sunstein lays out, I suspect that FATCA will not be going away soon though there are proposals that minimize costs without giving away too much in terms of the law’s effort to bring accounts into the sunshine.

The issue is politicized. FATCA and the IRS for that matter have been part of the presidential campaign, with Senator Paul for example suing to stop FATCA (see a post in Forbes by Robert Goulder discussing that unusual approach) and Senator Cruz noting that recent laws have contributed to the “weaponization” of the IRS leading to his calls to abolish the agency.

Expanding EITC

Primary season is usually not the time for reasoned discussion of many issues, and I do not put much stock in candidates’ IRS-bashing.  I put some more stock in the across the aisle call that President Obama noted when he referred to Representative Ryan and his support to alleviate poverty and in particular tax cuts for childless workers. I take that reference in the speech to the Administration and the Speaker’s support for expanding the EITC for childless workers (the current maximum EITC for childless workers is about $600 compared to $6,000 for families with three or more kids).

It seems like there is some momentum for the idea of expanding the EITC for childless workers.  Calls for EITC expansion invariably are accompanied by attention to the EITC’s overclaim rate.  In the recent PATH legislation one cost for the expanded EITC and credits generally for families was a series of compliance measures I wrote about last month, including a ban for reckless and fraudulent claimants, additional civil penalties and greater summary assessment powers.  If Congress expands the EITC for childless workers, I suspect that it may consider extra powers the IRS might need to ensure that any expansion does not lead to additional overclaims.  Yet as I discuss below, expansion in this context might in fact lessen an incentive for noncompliance.

In an article in the Kansas Law Review called Poor and Tax Compliance: One Size Does Not Fit All based on research originally done by sociologists Kidder and McEwen, I argue that the EITC compliance problem is best thought of as a series of distinct problems with varying categories of noncompliance.  In the article I set out eight differing categories connecting the overclaim to the likely source of the problem.  In other words, the overclaim rate reflects varying sources of overclaims, including for example overclaims relating to 1) errors that stem from preparers (brokered noncompliance) and 2) when people just do not know the complex and changing EITC rules or their circumstances change (unknowing noncompliance).

In the article I refer to symbolic noncompliance, noncompliance that is rooted in a sense that the law is unfair.  Consider now a single father who is current on child support and who spends considerable time with his kids, but who does not spend more than half the year with those kids.  Current rules treat the noncustodial parent as effectively childless, so the EITC is not worth much for that parent.

Just a few weeks ago a joint report of the right leaning American Enterprise Institute (AEI) and left leaning Brookings Institute called Opportunity, Responsibility, and Security noted how current laws fall short in providing incentives for single non-custodial parents (primarily fathers):

[A] single mother with two children working 30 hours a week at an $8-per-hour job is likely to receive annual benefits of $5,495 from the Supplemental Nutrition Assistance Program (SNAP) [food stamps], $4,990 in federal EITC payments, up to $2,000 through the Child Tax Credit (up to $1,422 is refundable through the Additional Child Tax Credit), and health care coverage that could reasonably be valued at $4,101 depending on her state of residence. Child support collections, school lunch and breakfast, and child care subsidies can provide additional resources.

By contrast, a nonresident father working the same job and living in the same area is likely to receive only $1,655 annually from SNAP, $179 from the federal EITC, and possibly some help with health insurance depending on where he lives.  But he also is likely to have a child support obligation that would reduce his income and increase the mother’s. Collectively, the benefits provided to the single mother can almost double what she earns, while the nonresident father is eligible for little more than SNAP and a minimal EITC benefit.  Discussions about family and poverty must focus more attention on encouraging more work among poor, nonresident fathers—not just among the single mothers of their children.

Changes to the law to allow a greater benefit to a noncustodial parent might shift the perception that the current benefit regime is stacked against single noncustodial parents and reduce the incentive for the noncustodial and custodial parent to collude and agree to a sharing of a child.  To be sure, some might argue that an expansion of the childless EITC may just encourage other types of noncompliance.  Yet it is not the presence of refundable credits that creates noncompliance.  If Congress expands the EITC for childless workers, rather than legislate knee-jerk approaches to increase penalties and reduce procedural protections, Congress might tether an expansion to the credit with more targeted eligibility requirements backstopped by IRS compliance efforts to ensure that an individual claiming an EITC in fact does have earned income.  Any action should be backed by research as to what is likely effective and also recognize that the IRS will need resources allocated to allow it to effectively administer the law.

Senate Again Takes Aim at Improper Payments in Federal Programs

Last week the Senate Finance Committee held a hearing on reducing improper payments in federal programs. The hearing considered not just tax. It covered 124 programs across the federal government in FY 2014 that have resulted in about $124.7 billion misspent, though the IRS got special attention as the EITC, along with Medicare and Medicaid, account for about 75% of the government-wide improper payments. The only witness at the hearing was GAO Comptroller Gene Dodaro, a graduate of Lycoming College, the alma mater of the great Stephen Olsen.

The hearing highlights the continued IRS emphasis on EITC, with Dodaro testifying that EITC claimants are twice as likely to get audited as non-claimants and that about 45% of all IRS correspondence audits focus on EITC. Moreover, Dodaro believes that the two most important legislative fixes Congress could do to help IRS administer EITC would be to give it authority to regulate unenrolled preparers and to accelerate the time to file information returns.


The hearing itself is good theater and also informative. Senator Hatch kicks it off at the 35 minute mark, noting the importance of the issue and framing the severity of the problem with what could be done with the money if it were not misspent (e.g., the improper payments would be enough to buy every American an Ipad or a year’s worth of meals at Chipotle, or on a more serious level health insurance for every person in Florida). Senator Wyden’s opening remarks starts off at the 42 minute mark, framing the discussion by noting that there are two key defining issues: one, that improper payments include payments that are too big, too small or documented in some wrong way. The second issue is out and out fraud. Senator Wyden notes that conflating fraud and improper payments generally is wrong.

GAO Comptroller Dodaro’s testimony starts at the 51 minute mark. His written testimony has lots of data and graphs and charts. He goes into EITC in great detail on page 13, and it looks at IRS compliance trends and that how in FY 14 IRS reported EITC program payments of $65.2 billion and estimated that about 27.2% or $17.7 billion in those EITC payments were improper.

Despite that attention-grabbing number, the GAO written testimony (page 33) describes the most significant source of the tax gap for individuals not as errors with credits such as EITC, but small business individual income underreporting:

Individual income tax underreporting accounted for most—about $235 billion—of the underreporting tax gap estimate for tax year 2006. Of that amount, IRS reported that over half—$122 billion—comes from individuals’ business income, including income from (1) sole proprietorships (persons who own unincorporated businesses by themselves), (2) partnerships (a group of two or more individuals or entities, such as corporations or other partnerships, that carry on a business), and (3) S-corporations (corporations meeting certain requirements that elect to be taxed under subchapter S of the Internal Revenue Code).

In his written testimony he summarized GAO’s view on the tax gap as follows and how IRS and Congress can reduce it as follows:

Addressing the estimated $385 billion net tax gap will require strategies on multiple fronts. Key factors that contribute to the tax gap include limited third- party reporting, resource trade-offs, and tax code complexity. For example, the extent to which individual taxpayers accurately report their income is correlated to the extent to which the income is reported to them and the Internal Revenue Service (IRS) by third parties. Where there is little or no information reporting, such as with business income, taxpayers tend to significantly misreport their income. GAO has many open recommendations to reduce the tax gap. For example, GAO recommended in 2012 that IRS use return on investment data to reallocate its enforcement resources and potentially increase revenues. Since 2011, GAO also recommended improvements to telephone and online services to help IRS deliver high-quality services to taxpayers who wish to comply with tax laws but do not understand their obligations. Other strategies GAO has suggested would require legislative actions, such as accelerating W-2 filing deadlines. Additionally, requiring partnerships and corporations to electronically file tax returns could help IRS reduce return processing costs and focus its examinations more on noncompliant taxpayers. Further, a broader opportunity to address the tax gap involves simplifying the Internal Revenue Code, as complexity can cause taxpayer confusion and provide opportunities to hide willful noncompliance.

At about the 58 minute mark, a good snapshot of the GAO position on EITC was in Dodaro’s response to questioning from Senator Hatch when the Senator described the EITC as “one of the most poorly administered federal programs” and asked if Dodaro agrees with that characterization. There Dodaro deflects from IRS bashing and notes that the EITC is difficult and complex to administer based on the challenges it faces in determining family arrangements and often its lack of information about income. Dodaro again emphasizes that IRS needs legislation to help it administer the program successfully. In particular, as I mention above, Dodaro believes that the two most important legislative proposals would be giving IRS authority to regulate paid preparers and accelerate the filing of information returns.

For those interested in the issue of regulating preparers, at about 1:01 is where GAO’s Dodaro gives his endorsement of legislation regulating preparers, including references to Oregon, one of the handful of states that has its own mandatory education and testing regime.

Parting Thoughts

There are many other specific proposals in the GAO testimony, including expansion of math error authority that I have many reservations about (and discussed previously), and a general call for simplifying the laws. For many reasons, Congress will always focus on errors in transfer programs such as the EITC. Given that the administration has proposed extending the prior expanded levels of EITC and has with some bipartisan support also called for expanding the EITC for childless workers it seems likely that the issues surrounding EITC compliance will receive an even greater amount of Congressional attention in the months ahead.