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Letter Report:
Overall, the Internal Revenue Service Processed Child and Dependent Care
Credits Correctly
July 2001
Reference Number:
2001-40-120
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July
23, 2001
MEMORANDUM
FOR COMMISSIONER, WAGE AND INVESTMENT DIVISION
FROM: Pamela J. Gardiner
/s/ Pamela J. Gardiner
Deputy
Inspector General for Audit
SUBJECT: Final Letter Report -
Overall, the Internal Revenue Service Processed Child and Dependent Care
Credits Correctly
This report
presents the results of our review to determine if the Internal Revenue Service
(IRS) correctly processed the Child and Dependent Care Credit. In summary, we found that the Internal
Revenue Service (IRS) did a good job of processing 5.7 million Child and
Dependent Care Credit claims totaling $2.5 billion. It validated most of the requirements for the
credit, which should significantly increase the likelihood that the credits
were correct. However, the IRS did not
ensure other requirements were met before allowing the credits. For example, taxpayers were allowed incorrect
amounts for credits for prior year expenses.
We recommended
that the Commissioner, Wage and Investment Division,
evaluate why tax examiners are not disallowing the prior year portion of the
Child and Dependent Care Credit when the required computation is not
provided. Steps should be taken to
address the problem based on the results of the evaluation. We also recommended the Commissioner, Wage and
Investment Division, clarify the instructions for Child and Dependent Care Expenses (Form 2441) and Child and Dependent Care Expenses for Form
1040A Filers (Schedule 2) to ensure taxpayers understand to put the amount
of the credit for the prior year expenses on the form as opposed to the amount
of the expenses incurred in the prior year.
Management’s
response was due on July 6, 2001. As of
July 13, 2001, management had not responded to the draft report.
The Treasury
Inspector General for Tax Administration (TIGTA) has designated this report as
Limited Official Use (LOU) pursuant to Treasury Directive TD P-71-10, Chapter
III, Section 2, “Limited Official Use Information and Other Legends” of the
Department of Treasury Security Manual.
Because this document has been designated LOU, it may only be made
available to those officials who have a need to know the information contained
within this report in the performance of their official duties. This report must be safeguarded and protected
from unauthorized disclosure; therefore, all requests for disclosure of this
report must be referred to the Disclosure Unit within the TIGTA’s Office of
Chief Counsel.
Copies of this
report are also being sent to the IRS managers who are affected by the report
recommendations. Please contact me at
(202) 622-6510 if you have questions or Walter Arrison, Assistant Inspector
General for Audit (Wage and Investment Income Programs), at (770) 936-4590.
TD P 15-71
The overall objective of this review was to determine if the Internal Revenue Service (IRS) correctly processed the Child and Dependent Care Credit. This audit is one in a series designed to evaluate the IRS’ processing of tax credits commonly claimed by Wage and Investment taxpayers.[1]
We performed our audit at the National Headquarters and the
Major contributors to this report are listed in Appendix I. Appendix II contains the Report Distribution List.
TD P 15-71
The
Child and Dependent Care Credit provides taxpayers relief for expenses they
incur for the care of their children or disabled family members while they
work.
The amount of the Child and Dependent Care Credit is calculated either as a percentage of the amount paid for the care (expenses are limited to $2,400 for the care of 1 person and $4,800 for the care of 2 or more persons) or as a percentage of earned income. This calculation is performed on Child and Dependent Care Expenses (Form 2441) or Child and Dependent Care Expenses for Form 1040A filers (Schedule 2). The maximum amount of the Child and Dependent Care Credit is $720 for the care of 1 person and $1,440 for the care of 2 or more persons.
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Overall, the IRS did a good job of processing the 5.7 million TY 1999 Child and Dependent Care Credits totaling $2.5 billion.[2] It validated the accuracy of several important requirements for claiming the credit, such as maximum amounts, information about the qualifying person, earned income,[3] and provider information.
However, the IRS has an opportunity to further improve its
processing by ensuring that amounts claimed for prior year expenses are
accurate. Also, we could not readily
determine if taxpayers complied with certain other requirements before the
credit was allowed because sufficient information was not provided with the
Forms 2441. While the IRS could rely on
subsequent examinations to validate the credits, it did not have an assurance
that these requirements were met before taxpayers received the credits.
An overview of the requirements for receiving this credit and whether the IRS validates this information before the credit is allowed is provided in Appendix IV.
The Internal Revenue Service Validated Most Requirements for Claiming the Child and Dependent Care Credit
Maximum limit
The maximum credit is $1,440 plus a percentage of prior year expenses. We performed a computer analysis of approximately 3 million TY 1999 returns with Child and Dependent Care Credits totaling $1.3 billion that were processed either electronically or at the ATSPC or KCSPC. Virtually all (99.99 percent) of the credits were within the limits.[4]
The IRS computer is programmed to calculate the amount of the credit.
The IRS captured information from the Form 2441 or Schedule 2 provided by the taxpayer and re-computed the credit based on this and other information from the tax return, such as adjusted gross income. This process limited the credit amount for expenses incurred in the current year to $720 or $1,440, depending on the number of persons receiving care. The IRS identified and analyzed any return where the taxpayer’s credit amount differed from the computer’s amount.
Qualifying person
Qualifying persons must have a valid SSN.
Taxpayers were required to provide the name and social security number (SSN) of the person cared for. The IRS had checks in place to ensure that this information was provided and accurate. The IRS captured information provided by the taxpayer and validated it against the IRS computer files. Any differences were reviewed and corrected. If the IRS determined that the SSN was not valid, the credit was disallowed and a notice was sent to the taxpayer.
Earned income
Taxpayers must have earned income to qualify for the credit. The IRS had procedures to validate this requirement. The IRS captured the earned income amount provided by the taxpayer and used it when calculating the amount of the credit. If the IRS determined that the taxpayer did not have earned income, the credit was disallowed and a notice was sent to the taxpayer.
Provider information
Taxpayers were required to provide information (name, address, identifying number, and amount paid) about their childcare provider. At the time of our review, the IRS ensured that this information was provided but did not validate its accuracy. In 2001, it improved this process by adding a feature that would enable validation of the provider information. However, the programming changes were limited to only capturing the information about one provider.
The Internal Revenue Service Did Not Ensure
Certain Requirements Were Met Before Allowing the Credit
Credit for prior year expense
Taxpayers can receive credit for expenses they incurred in 1998 but did not pay until 1999.
In addition to receiving a credit for the current year expenses, taxpayers can receive a credit for expenses that were incurred in the prior year but not paid until the current year.
The IRS processed 3,212 TY 1999 returns nationwide where the Child and Dependent Care Credit included a credit for the prior year expense. Our computer analysis identified 1,367 of these, totaling approximately $943,000, that were processed either electronically or at the ATSPC or KCSPC. We reviewed a judgmental sample of 115 tax returns and determined that in 84 cases (73 percent) taxpayers were allowed $68,510 more than they should have received, due to an incorrect computation of the credit for prior year expenses. In the remaining 31 cases, taxpayers correctly computed the credit for the prior year expenses. While we did not test the other 1,845 tax returns with the prior year expense that were processed at the other 8 IRS Submission Processing Centers, we have no reason to believe that this condition would not also exist in those other locations.
This may have occurred because the instructions for calculating the credit were not clear and taxpayers were incorrectly allowed the credit when they did not provide the supporting statement showing the calculation.
Taxpayers were instructed to write “PYE” and the amount of credit for TY 1998 expenses they paid during TY 1999 on their Form 2441 or Schedule 2. They also were required to attach a statement showing how they figured the credit. The instructions telling the taxpayer how to report the amount of the credit they can claim for prior year expenses were not clear. Taxpayers could have been confused because “PYE” is an acronym for prior year expense; however, the amount they were to enter was the credit for the prior year expense only, not the entire prior year expense.
The IRS does not ensure the taxpayer submitted a supporting schedule showing the calculation of the credit for prior year expense.
Also, in a report on the IRS’ 1998 Filing Season[5] issued in August 1998, the auditors recommended that the IRS not allow the credit when the computation for the credit for prior year expenses is not provided by the taxpayer. The IRS stated in the report that to correct the problem, it issued instructions to tax examiners requiring them to disallow the prior year portion of the credit when the required computation is not provided. However, the IRS continues to have problems in this area.
1. The Commissioner, Wage and Investment Division, should evaluate why tax examiners are not disallowing the prior year portion of the Child and Dependent Care Credit when the required computation is not provided. Steps should be taken to address the problem based on the results of the evaluation.
Management’s Response: Management’s response was due on July 6, 2001. As of July 13, 2001, management had not responded to the draft report.
2. The Commissioner, Wage and Investment Division, should clarify the instructions for Form 2441 and Schedule 2 to ensure taxpayers understand to put the amount of the credit for the prior year expenses on the form as opposed to the amount of the expenses incurred in the prior year.
The IRS had checks in place to validate key requirements for claiming the Child and Dependent Care Credit. However, it could further improve its processing effectiveness by ensuring that all prior year expenses are accurate.
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Appendix I
Walter E. Arrison, Associate Inspector General for Audit
(Wage and Investment Income Programs)
M. Susan Boehmer, Director
Deann L. Baiza, Audit Manager
Patricia H. Lee, Audit Manager
Areta
Heard, Auditor
Sharla J. Robinson, Auditor
Ron Stuckey, Auditor
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Commissioner N:C
Deputy Chief Financial Officer, Department of the Treasury
Director, Customer Account Services W:CAS
Director, Electronic Tax Administration W:ETA
Director, Submission Processing W:CAS:SP
Field
Director, Submission Processing (
Field
Director, Submission Processing (
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Appendix III
Outcome Measures
This appendix presents detailed information on the measurable impact that our recommended corrective actions will have on tax administration. These benefits will be incorporated into our Semiannual Report to the Congress.
Type and Value of Outcome Measure:
· Revenue Protection – Actual; 84 taxpayer accounts affected totaling $68,510 (see page 5).
Methodology Used to Measure the Reported Benefit:
By querying the Internal Revenue Service computer system
for tax returns filed from January 16, 2000, to September 9, 2000, we
identified 3,212 TY 1999 tax returns
nationwide, totaling $2,270,440.46, that met the criteria of having a Child and
Dependent Care Credit for prior year expenses greater than $0.
From this analysis, we identified all
returns filed electronically or at the
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Appendix IV
Requirements to Claim the Child and
Dependent Care Credit
|
Requirement |
Does the Internal
Revenue Service (IRS) validate the requirement before the credit is allowed? |
|
The Child and
Dependent Care Credit should not exceed maximum limit. |
Yes. The IRS’ computer is programmed to
calculate the credit. |
|
Information
about the qualifying individual should be included on the Form 2441 or
Schedule 2. |
Yes. This information is validated for accuracy.[6] |
|
Taxpayer
and spouse, if applicable, must have earned income. |
Yes. If earned income is not present, the credit
is disallowed.[7] |
|
A
supporting statement should be attached to the return showing the computation
of the credit for prior year expenses claimed. |
Yes. The IRS has a requirement to disallow the
credit if the statement is not attached; however, this procedure is not
always followed. |
|
Information
about the care provider should be included on the Form 2441 or Schedule 2. |
Yes. The IRS verifies that the information is
present but does not validate the accuracy of the information. |
|
The
qualifying person must be any child under age 13 or a disabled person who can
be claimed as a dependent (with exceptions) or a disabled spouse. |
No. The IRS does not determine if the
qualifying person is disabled or 13 years or older.[8] |
|
Expenses
used to compute the credit amount must be qualifying expenses. |
No. The IRS does not determine if the expenses
incurred were “qualified.”[9] |
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[1] The
Treasury Inspector General for Tax Administration (TIGTA) also has ongoing
audits of the Adoption, Education, Elderly or the Disabled, and Mortgage
Interest Credits. The TIGTA previously
issued audit reports on the Earned Income Credit (Management Advisory Report:
Administration of the Earned Income Credit (Reference Number
2000-40-160, dated September 2000)) and the Child Tax and Additional Child Tax
Credits (The Internal Revenue Service Had
a Successful 2000 Filing Season; However, Opportunities Exist to More
Effectively Implement Tax Law Changes (Reference Number 2001-40-041, dated
January 2001)).
[2] These figures represent all TY 1999 returns processed with the Child and Dependent Care Credits between January 16 and September 9, 2000 (all return data available when we obtained the electronic information for review). All subsequent references to TY 1999 returns use this same processing period.
[3] Earned income is salaries, wages, tips, and other amounts received as pay for work performed.
[4] We identified 395 out of 3 million tax returns with Child and Dependent Care Credits totaling $500,000 that were over the maximum limit.
[5] On-Line Review of the 1998 Filing Season (Reference Number 085408, dated August 7, 1998).
[6] We reviewed the IRS’ documentation for this control but did not test it to evaluate its effectiveness.
[7] Ibid.
[8] We did not test this requirement because the taxpayer is not required to provide information on whether the person cared for is disabled on the return
[9] We did not test this requirement because specific information about the qualifying expenses, needed to evaluate if this requirement was met, is not provided by the taxpayer on the return. However, the IRS could rely on examinations conducted after the taxpayers receive the credit to review the requirement.