Going Forward – Refundable Credits in the 2021 Filing Season and Beyond

A second proposal I made in that post received some interesting comments.  I proposed the IRS use its internal Form W-2 and 1099-MISC-NEC data to identify those taxpayers who appeared to qualify for the childless worker Earned Income Tax Credit (EITC) and automatically pay out the amount of EITC based on those earnings.  By now, the IRS has received almost all of the wage and information returns for 2019.  The National Taxpayer Advocate reports that by February 28, 2020, the IRS had received 3.9 percent more W2s and 12.8 percent more 1099-MISC forms than the year before.  (For comparison, the IRS received 219 million W2s by February 4, 2019.)    IRS also can determine whether the taxpayer was claimed as a dependent on another’s return, so the risk of noncompliance is very low.  In fact, in 2018 the Treasury Inspector General for Tax Administration, whose job is to ferret out fraud, waste, and abuse in the tax administration, actually recommended the IRS automatically calculate and pay out the EITC.

One comment questioned how someone could live on, say, $7,000 a year and cited an example of a client who, upon questioning, ceded that he had unreported cash income.  Another noted that one of his clients had low wage income but was receiving a significant amount of income that was reported on an estate’s Schedule K-1, which likely would not be in the IRS’s systems yet.  I will address the issue of living off of $7,000 a year below, but as to the K-1 income, my response is something I have said to the IRS for decades:  you design tax administration around the 95 percent of the taxpayers who are trying to comply, not around the 5 percent who are not.  No aspect of tax administration will have zero errors or noncompliance; you have to accept some people will slip through.  Otherwise, you end up with the byzantine tax administration we have now. 

The proposals outlined in my earlier post don’t solve all the problems with unclaimed EITC or missed EIPs.  They addressed emergency situations and provided a one-time way to get much needed dollars out to the most vulnerable populations in our society, populations that are most impacted by the coronavirus and pandemic-related job loss.  For 2021 and beyond, the IRS can build on its EIP initiatives this year to increase the EITC participation rate while minimizing taxpayer burden.  But before I discuss these proposals, let’s take a high-level look at poverty in America.

Refundable tax credits play an important role in reducing poverty in America

According to the US Census Bureau, the 2018 official poverty rate was 11.8 percent, with 38.1 million people in poverty.  The official definition of poverty is established by the Office of Management and Budget in Statistical Poverty Directive 14 and is used to determine eligibility for various government programs.  Here are some rather stunning statistics from the U.S. Census Bureau report, Income and Poverty in the United States: 2018, (the 2019 poverty statistics will be issued on September 15, 2020).  For purposes of determining family poverty, Census defines a family as “a group of two or more people related by birth, marriage, or adoption and living together.”

• The 2018 poverty rate for primary families (i.e., a family that includes a householder) was 9.0 percent.
  • For female householder families, the rate was 24.9%.
  • For married couples, the rate was 8.1%.
• The 2018 poverty rate for unrelated individuals not in families was 20.2%.  (This is a cohort of the childless worker EITC population.)
  • For unrelated male individuals not in families, the rate was 17.7%.
  • For unrelated female individuals not in families, the rate was 22.6%.
• The 2018 poverty rates varied significantly by race:
  • For Blacks, the rate was 20.8%.
  • For Hispanics, the rate was 17.6%.
  • For non-Hispanic Whites, the rate was 8.1%.
• The 2018 poverty rate varied by sex:
  • For males, the rate was 10.6%.
  • For females, the rate was 12.9%
• The 2018 poverty rate varied significantly by age:
  • For children under the age of 18, the rate was 16.2%.
  • For persons age 65 or older, the rate was 9.7%.
• The 2018 poverty rate for workers was 5.1%.
  • For full-time year-round workers, the rate was 2.3%.
  • For less-than-full-time year-round workers, the rate was 12.7%.
  • For workers who did not work at least 1 full week, the rate was 29.7%.

The Department of Health and Human Services publishes the poverty guidelines each year in the Federal Register.  The 2020 poverty guidelines are below:

Since 2011, in collaboration with the Bureau of Labor Statistics, the Census Bureau has also computed and published the Supplemental Poverty Measure (SPM), which takes into account the impact of government benefit programs for low income persons and families – including food stamps, school lunches, housing assistance and refundable tax credits —  as well as deductions for certain necessary expenses, including taxes, child care, commuting, health insurance premiums and co-pays, and child support, that are not included in calculating the official poverty rate.  Here are a few eye-opening factoids from the SPM:

• For 2018, the Supplemental Poverty Measure was 12.8 %, a full percentage point higher than the official poverty rate.
• Social Security benefits moved 27.2 million persons out of poverty in 2018.
• Refundable tax credits moved 8.9 million persons out of poverty in 2018.
• If the EITC and the refundable portion of the Child Tax Credit were not included in the SMP calculation, the 2018 SPM poverty rate would have been 15.5 % rather than 12.8 % — meaning the tax code accounts for an almost 4 percentage point reduction in the official poverty rate of 11.8 %.

The Supplemental Poverty Measure shows that it is possible for someone to live on earnings of $7,000 a year by receiving federal benefits, including the Earned Income Tax Credit.  In fact, according the U.S. Census Bureau, 10.2 percent of over 128 million householders had money income under $15,000 in 2018.  That is the reality for over 13 million Americans.

Going forward, the IRS needs to take more proactive steps to get the EITC and other refundable credits into the hands of eligible taxpayers

The stunning data presented above should give us all pause to reflect on the significant role the tax code and IRS play in lifting Americans out of poverty.  Although some complain that the IRS should not be in the benefits business (or, more cynically, it should only be administering social benefits to home-owners and businesses), it turns out the EITC is an efficient and effective program.  Yes, there are plenty of things that need fixing about the EITC, and I personally have made scores of recommendations in that regard.  But folks who wish for a past time when the EITC didn’t exist need to just get over it.  And that includes the IRS – it needs to embrace its role as deliverer of social benefits.

The IRS can begin its embrace in the 2021 filing season and beyond, by keeping the non-filer portal and enhance it by adding a screen and checkboxes designed to determine eligibility for the EITC.  The IRS’s own data show that through April 17, 2020, 5.631 million filers used Free File, a 110 percent increase over 2019, largely attributable to taxpayers who used the non-filer portal and thus bumped up the abysmal Free File usage rates.  [See National Taxpayer Advocate Fiscal Year 2021 Objectives Report to Congress, pages 97-98.]  Usage would increase even more if the portal were made available on mobile devices as well as in other languages.  Moreover, the IRS could consider a telefile version of the nonfiler portal – which would really help out those households who don’t have broadband or any internet access in their homes.

In 2018, TIGTA recommended the IRS modify Form 1040 to capture information that would allow it to automatically issue the EITC to taxpayers who filed a return.  Although the IRS ultimately declined to go along with this recommendation, it is a good idea that should be adopted.  Here is TIGTA’s suggested mock-up for the pre-“simplified” Form 1040:

In addition to adding these boxes to the face of the Form 1040, IRS should add to the non-filer portal a few extra checkboxes:  Did you (and your spouse, if filing married-filing-jointly) have your principal residence in the US for more than six months of the year?  Would you like the IRS to compute your eligibility for and amount of the Earned Income Tax Credit?  If a taxpayer enters dependents on the nonfiler portal, another checkbox can pop up:  Did this child live with you in the US for more than six months of the year?  These questions, along with retaining the checkbox question about being claimed as a dependent on another’s return and IRS internal databases and filters, provide all the information the IRS needs to get the EITC out to eligible households.

Second, as TIGTA recommended in 2018, the IRS should study how best to use CP-09 and CP-27 letters, the EITC reminder notices IRS sends to taxpayers with children and without children, respectively.  Today, IRS sends out these letters to only a fraction of taxpayers it believes are eligible for underclaimed EITC, and it completely ignores those who have not filed a return.  According to TIGTA, for Tax Year 2014, IRS estimated 5 million households were potentially eligible for EITC totaling $7.3 billion.  Of those 5 million taxpayers, 1.7 million filed returns but did not claim the EITC.  TIGTA reported the IRS annually spends $2 million issuing notices to potentially eligible taxpayers, but the notices were sent to only 361,000 of the 1.7 million filers (and none to the nonfilers).  The response rate to these letters was 28 percent for taxpayers with children, and 57 percent for taxpayers without children.   The CP-09 and CP-27 letters may not be necessary for filers if the IRS adopted TIGTA’s and this post’s recommendations to modify the Form 1040 and the non-filer portal.  Instead, these letters (or postcards) could be sent at the beginning of the filing season to prompt nonfilers to file and claim the EITC.   

As TIGTA noted, the CP-09 and CP-27 letters historically have had low response rates.  But thousands of businesses and political campaigns have figured out that direct marketing, done correctly, actually has an impact.  The IRS possesses a mother lode of data on nonfilers – it has Forms W-2 and 1099s; all of those forms have taxpayer addresses.  The IRS could use this address data to send the letters, or generic postcards, to EITC nonfilers.  A postcard with a generic message about EITC eligibility, can be written so as to not violate IRC § 6103.  For example: 

The EITC is a tax credit for low income workers with or without children. To learn whether you are eligible for the credit, go to [website] or call [toll-free dedicated number]. If you haven’t filed a return, you may be able to use the non-filer portal to claim the EITC.

It may be people don’t open IRS letters, but they will read a generic postcard about needing to file in order to get the EITC.  This is worth experimenting with. 

The IRS could also send letters to potentially eligible filers and nonfilers immediately before the opening of the next filing season, urging people to check out the EITC; a TAS study found that educational letters, sent to taxpayers who appeared ineligible for the EITC in the previous year but were not audited, with the words “important tax information” on the envelopes and mailed right when W-2s were being issued, resulted in significant taxpayer behavior changes.  Recipients apparently opened the envelopes and read them. 

IRS also could promote the non-filer portal during its EITC Awareness Day events every January.  Moreover, since the non-filer portal is built upon the Free File Alliance’s Free Fillable Forms portal, as discussed here, it won’t run afoul of the IRS-FFA agreement.

In the past, the IRS cited lack of resources to be able to handle the responses to more of the  CP-09 and CP-27 notices.  As I’ve noted in other posts, I understand all too well the problem of diminished resources.  But EITC funds are lifelines to these taxpayers and should be prioritized as much as enforcement hires.  If the IRS were to adopt a dual-role mission statement, as I’ve recommended since 2010, it and the Administration would develop a budget proposal to provide the resources and staffing necessary to issue the notices and process responses.  Moreover, if the IRS maintains and improves the portal, nonfilers would use the portal instead of mailing in a response, so the resource demand would be minimized.  Congress has a role to play here, too.  It can nudge the IRS in the right direction and provide it with dedicated funding to increase the EITC participation rate.  With the pandemic showing the vital role the IRS plays in the delivery of economic benefits, Census data showing the important role of refundable tax credits in lifting millions of Americans out of poverty, and Congress finally aware of what years of underfunding have done to tax administration, now is the time to make the case for robust and proactive taxpayer assistance.