The Selection of Earned Income Tax Credit Returns for
Examination Can Be Improved to Further Prevent Erroneous Payments
October 2003
Reference
Number: 2004-40-004
This report has cleared the Treasury
Inspector General for Tax Administration disclosure review process and
information determined to be restricted from public release has been redacted
from this document.
October
30, 2003
MEMORANDUM FOR
COMMISSIONER, WAGE AND INVESTMENT DIVISION
FROM: Gordon C. Milbourn III /s/ Gordon C. Milbourn III
Assistant Inspector General
for Audit (Small Business and
Corporate Programs)
SUBJECT: Final Audit Report - The Selection of Earned Income Tax Credit
Returns for Examination Can Be Improved to Further Prevent Erroneous Payments (Audit # 200340039)
This
report presents the results of our review of the Internal Revenue Service’s
(IRS) selection of Earned Income Tax Credit (EITC) cases for examination. The overall objective of our review was to
determine whether the IRS’ process for selecting EITC cases for examination is
providing the best effect on compliance and fairness to taxpayers. Specifically, we determined if the Dependent
Database examination case selection process for EITC returns results in the
greatest benefit at the least cost (cost-benefit) while ensuring taxpayers are
treated fairly and uniformly under the law.
The
EITC is a major Federal Government effort to assist the working poor. The IRS has the responsibility for
administering the EITC, which is a refundable credit available to taxpayers who
file returns with certain earned income.
Historically, the EITC Program has been vulnerable to high rates of
noncompliance (overclaims). Based on an
IRS report, an estimated $8.5 to $9.9 billion (27 to 32 percent) of the
estimated $31.3 billion in EITC claims made by taxpayers for Tax Year 1999
should not have been paid.
The mission of the EITC Program is to ensure that eligible taxpayers receive the EITC and that unsubstantiated claims are eliminated. One of the major goals of the EITC Program is to “implement a balanced compliance program to increase voluntary compliance.” The Dependent Database examination case selection process is part of that balanced compliance program and is focused on selecting taxpayers whose EITC claims based on qualifying children may be unsubstantiated.
The
IRS has a good process for evaluating the results of the Dependent Database
case selection process that allows for necessary adjustments to be made. In addition, the types of returns selected
for examination through the Dependent Database process are representative of
taxpayers who claim the EITC based on qualifying children. However, the IRS cannot determine if the
selection process ensures that resources are being used to provide the greatest
cost-benefit because it does not use cost data and yield in the evaluation of
the case selection process. Use of
cost-benefit data in its evaluation process would help assure the IRS that its
selection process provides the most productive combination of returns for
examination.
We
recommended that the Commissioner, Wage and Investment (W&I) Division,
complete an analysis of closed Dependent Database examination cases to
determine if relationships exist among direct examination time, rules
identified, and disposition of the examinations. If a relationship exists, cost-benefit data based on this
relationship should be incorporated into the criteria used to score tax
returns. If no relationship exists, an
average cost of examinations should be used to conduct the cost-benefit analysis. The Commissioner, W&I Division, should
also incorporate the cost-benefit analysis into the Dependent Database
Risk-Based Scoring Model planned for implementation in January 2004.
Management’s
Response: IRS management agreed with our
recommendations. The Director,
Reporting Compliance, W&I Division, will analyze Fiscal Year (FY) 2003
Dependent Database closed case data and attempt to group returns by rules
broken and assign costs to those groups.
The Director, Reporting Compliance, W&I Division, also will
incorporate a cost-benefit analysis into the Dependent Database selection
process; however, IRS management stated that they would be unable to do so
until January 2005. Although IRS
management agreed with our recommendations, they did not concur with our
outcome measure of $20.9 million in additional overclaims that could have been
protected. The IRS stated that it needs
to conduct a comprehensive analysis using complete FY 2003 data to make this
determination. We agree that we did not
use complete FY 2003 data to calculate our outcome. However, the outcome was calculated using a significant portion
of the FY 2003 data. We also used cost
and examination outcome data provided by the IRS. Therefore, we believe our calculation
of the additional overclaims that could be protected is reasonable.
Management’s complete response to the
draft report is included as Appendix VII.
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 Michael R. Phillips, Assistant
Inspector General for Audit (Wage and Investment Income Programs), at (202)
927-0597.
Appendix
I – Detailed Objective, Scope, and Methodology
Appendix
II – Major Contributors to This Report
Appendix
III – Report Distribution List
Appendix IV
– Outcome Measures
Appendix V
– The Dependent Database Scoring Program
Appendix VI –
Cost-Benefit Analysis
Appendix VII
– Management’s Response to the Draft Report
The Earned Income Tax Credit (EITC), a major Federal Government effort to assist the working poor, is a refundable credit available to taxpayers who file returns with certain earned income. The Internal Revenue Service (IRS) is responsible for administering the EITC.
The Congress has long been concerned with the administration of the EITC Program. The IRS estimated that between $8.5 and $9.9 billion (27 to 32 percent) of the $31.3 billion in EITC claimed for Tax Year (TY) 1999 was in error. One of the main causes for these errors was taxpayers claiming children who did not meet the qualifications for the EITC. Children used by taxpayers to qualify for the EITC must meet relationship, age, and residency tests.
In an attempt to address EITC errors, the Congress passed the Taxpayer Relief Act of 1997 (TRA 97), which provided a means for the IRS to improve its examination selection process. The TRA 97 includes a provision that gives the Department of the Treasury access to data collected by the Department of Health and Human Services (HHS).
The IRS developed a computer system, known as the Dependent Database, to incorporate the data acquired from the HHS into the processing of individual tax returns. The IRS also incorporated criteria from its original examination selection process, known as the Electronic Fraud Detection System, which uses common characteristics from past erroneous EITC claims as the basis for selecting tax returns for examination.
The IRS uses the Dependent Database to
identify and select for examination those tax returns with possible erroneous
EITC claims (EITC overclaims). During
the examination selection process, the Dependent Database scoring program first
analyzes tax returns that have claimed at least one EITC-qualifying child or
dependent child. Using data from
several sources, it analyzes each tax return for criteria that indicate the
taxpayer might not be eligible for the EITC and assigns a numeric value to each
criterion. These criteria were
developed into a comprehensive set of rules used to score the returns. The Dependent Database then produces an
overall score for each return based on the rules that apply to that
return.
Based on resources available to conduct
examinations, the IRS selects certain types and quantities of returns for
examination to verify taxpayers’ eligibility for the EITC. Appendix V provides additional information on
the Dependent Database scoring process.
Once the examination selection process is
complete, returns selected by the Dependent Database are examined before a
refund is sent to the taxpayer. This is
known as a pre-refund examination. The
IRS Wage and Investment (W&I) Division conducts examinations of returns on
which taxpayers claimed wages to qualify for the EITC, and the Small
Business/Self-Employed (SB/SE) Division conducts examinations of returns on
which taxpayers claimed self-employment income to qualify for the EITC.
For the most part, EITC examinations are
handled as correspondence examinations (i.e., through the mail). Correspondence examinations can be completed
in a few hours, are limited in scope to a few issues, and do not include a
review of detailed accounting records.
The IRS plans to expand its use of the
Dependent Database to include selecting taxpayers who must certify their
eligibility for the EITC either before the return is filed or at the time the
return is filed for TY 2003. It is also
studying the feasibility of developing rules to identify other issues, such as
charitable deductions, education credits, child credits, and child care
credits, to select non-EITC returns for examination.
We conducted this audit to determine whether the IRS’ process for selecting EITC claims for examination provides the best effect on compliance and fairness to taxpayers. Specifically, we determined if the Dependent Database examination case selection process for EITC returns results in the greatest cost-benefit while ensuring taxpayers are treated fairly and uniformly under the law. We did not determine if the rules being used by the Dependent Database to select returns are the most efficient, nor did we determine if the Database uses all information available to the IRS when scoring and selecting returns for examination.
This audit was performed between February and June 2003. The review included visits to the Office of Compliance and the EITC Program Office in the W&I Division Headquarters in Atlanta, Georgia, and the Office of Compliance in the SB/SE Division Headquarters in Washington, D.C. The audit was conducted in accordance with Government Auditing Standards. Detailed information on our audit objective, scope, and methodology is presented in Appendix I. Major contributors to the report are listed in Appendix II.
The Dependent Database examination selection process supports the mission of the IRS EITC Program and provides a balanced Examination inventory. The IRS also has a good process to evaluate whether the selection process chose the desired types of cases and to make any necessary changes.
The examination selection process focuses on the goals
and strategies of the EITC Program
The mission of the EITC Program is to ensure that eligible taxpayers receive the EITC and unsubstantiated claims are eliminated. One of the major goals of the EITC Program is to “implement a balanced compliance program to increase voluntary compliance.” The IRS also has a strategy to develop an enhanced initiative to reduce EITC overclaims by developing cross-divisional Examination strategies that quickly react to changing EITC compliance trends.
IRS employees explained that the goals of the Dependent Database examination selection process are to better identify and select noncompliant EITC returns for examination, provide a balance between the no-change rate and agreed rate, and provide coverage of high-risk areas of EITC claims. This supports the mission of the EITC Program to ensure that eligible taxpayers receive the EITC and unsubstantiated claims are eliminated. Selection of the EITC examination case workload through the Dependent Database also results in a cross-divisional Examination program providing returns for examination by both the SB/SE and W&I Divisions.
Analyses of the Dependent Database and EITC claimant population showed the returns selected reflect the characteristics that the IRS has identified as being potentially erroneous. In addition, the returns selected reflect the characteristics of the overall population of taxpayers that claimed the EITC. Both support the IRS’ goals to better identify and select noncompliant EITC returns for examination and to provide coverage of high-risk areas of EITC claims.
In its evaluation of compliance on TY 1999 returns with EITC claims, the IRS determined that the largest area of noncompliance was taxpayers who claimed qualifying children that they were not entitled to claim. The Dependent Database is designed to detect this area of noncompliance. An analysis of the IRS Individual Master File for TYs 2000 and 2001 showed that the characteristics of the rules applied during the Dependent Database scoring process are representative of the types of errors made by taxpayers claiming qualifying children when claiming the EITC.
In addition, returns selected for examination through the Dependent Database process generally reflect the makeup of the EITC-qualifying child population. In TYs 2000 and 2001, over 98 percent of the returns filed claiming an EITC-qualifying child also claimed a dependent. For these 2 years, over 97 percent of the returns selected using the Dependent Database claimed an EITC-qualifying child and a dependent.
Although the IRS selects returns that reflect the majority of the EITC-qualifying child population, it also selects returns in categories that have been identified as having a historically high risk for noncompliance (i.e., claiming the EITC when the taxpayer does not qualify). Two categories of return selection include income and filing status issues. Selection of examination case workload is also dependent on the number of resources available to conduct examinations.
The examination selection process is regularly evaluated and changes are made when necessary
The IRS periodically evaluates and refines the Dependent Database scoring and selection processes. Annually, the IRS conducts research on the results of examinations from each tax return processing year and uses these results to determine if the Dependent Database is selecting the desired types of returns for examination. The IRS also monitors and modifies the Dependent Database examination selection process as the filing season progresses.
The IRS uses its annual analyses to make enhancements to the Dependent Database examination selection process. Because examination cases can take several months to complete, changes to the selection process for an upcoming processing year are based on examination results from 2 years prior. For example, enhancements to the Dependent Database process for TY 2002 returns were based on the IRS’ analysis of examinations of TY 2000 returns.
The IRS uses its analysis in an attempt to continually improve the Dependent Database examination selection process. In addition to modifying the scoring and selection criteria to choose more returns that break multiple rules, the IRS has also:
· Initiated a study of taxpayers whose returns have broken rules in multiple years but were not selected for examination.
· Initiated a project, called the Risk-Based Scoring Model, to better align the number of points a return receives in the Dependent Database scoring process to the likelihood that the EITC or tax liability would be adjusted as a result of an examination.
While the IRS has a good process for evaluating the Dependent Database examination selection process to determine if it is choosing the desired types of returns, the IRS could improve the process by also considering the costs directly associated with and the yield expected from examining the returns (cost-benefit). This would allow the IRS to identify which examinations provide the best cost-benefit and are the most productive (i.e., which examinations cost the least to work while protecting the most revenue). When selecting examinations, the IRS takes into consideration the following factors:
· The historical no-change rate and the agreed rate on tax returns examined for each rule in the scoring process.
· The balance in coverage among the various selection criteria and types of returns being selected.
· The historical compliance patterns for different types of returns.
In addition, the IRS generally incorporates a tolerance into its EITC examination selection process. Specifically, the IRS does not select for examination returns on which the EITC falls below a certain dollar amount.
Currently, IRS systems do not adequately capture the costs
or time to examine specific types of returns.
Both of these factors are needed to determine how much it costs the IRS
to examine specific types of returns.
The IRS’ financial tracking systems do not adequately capture specific
cost data related to conducting various types of examinations, including EITC
examinations selected through the Dependent Database. Its Audit Information Management System (AIMS), the automated system the
IRS uses for examination case workload management, does capture examination
time applied directly to examining tax returns. However, the IRS does not believe the time captured on the AIMS
is a true measure of the time it takes IRS employees to examine tax returns
because examiners track their time only in 10‑minute intervals. Also, the IRS considers clerical time a key
factor in processing cases; however, the AIMS does not track this time.
The IRS stated that should it be able to adequately track the time spent examining returns, time from prior closed examinations still could not be used to predict how much time it will take to examine returns with the same issues. Therefore, it may not be able to introduce cost and time into the examination selection process.
We agree that there are many factors that influence how long it takes to complete an examination of tax returns, including, for example, the number of issues or questions on the returns and taxpayer behavior. Taxpayer behavior is a significant factor in Examination cases. Specifically, IRS examiners work fewer hours examining a tax return when taxpayers do not respond, or do not respond with adequate support for documents requested, than they do when taxpayers make multiple contacts with the IRS or the examiners have to ask for additional information. In addition, taxpayer behavior cannot always be directly linked to issues or the final resolution of cases (i.e., no-change, agreed, unagreed, or with no response from the taxpayer).
However, the IRS does not know if there is any relationship among the time to examine returns, the issue or number of issues questioned on returns, or the disposition of the examination because it has not done an analysis to determine this relationship. This type of analysis might allow the IRS to use historical data to introduce cost-benefit results into the overall scoring for EITC returns.
Although the IRS does not capture specific cost data for the different types of examinations, the IRS was able to provide us with an estimated average cost of $185.32 for each EITC examination. This amount includes the cost to conduct all EITC examinations, including pre- and post-refund EITC examinations, as well as those examinations conducted through other EITC compliance programs.
Using these estimated cost data, we conducted an analysis comparing the cost and yield of the TY 2001 tax returns selected by the Dependent Database for examination between January and August 2002. Our analysis showed that the IRS could have protected approximately $20.9 million in additional erroneous EITC claims if it had incorporated examination costs and yield into its examination selection process. Detailed information on our analysis can be found in Appendix VI.
General cost data provided by the IRS show that it cost the IRS approximately $31 million to conduct EITC examinations of TY 2001 returns selected by the Dependent Database process from January to August 2002. Program-specific cost-benefit data would provide the IRS better assurance that its selection process results in the use of those funds to achieve the best outcome from its Dependent Database examinations.
Results of a cost-benefit analysis should be part of the criteria for the rules used by the Dependent Database to score returns for examination selection. Adding cost-benefit data into the criteria used for the rules would not only provide the IRS a better means to determine if it is selecting the cases with the best potential for protecting EITC overclaims, it would also provide the IRS an effective method for integrating its budget with its program performance. The Government Performance and Results Act of 1993 (GPRA) and The President’s Management Agenda, Fiscal Year 2002, both require Federal Government agencies to link their budgets and their evaluations of program performance. In addition, the General Accounting Office has reported the need to develop reliable cost-benefit data to estimate the tax revenue collected by the IRS for each dollar spent pursuing these amounts. The Treasury Inspector General for Tax Administration has also reported the need to develop performance measures linking results to the funds requested.
The Commissioner, W&I Division, should:
1.
Complete an analysis of the historical Dependent Database
examination data to determine if there is a relationship among the direct
examination time, rules identified, and disposition of examinations. If there is a relationship, cost-benefit
data should be incorporated into the criteria used in the rule score for the
Dependent Database case selection process.
Absent a relationship, an average cost of examinations should be used to
conduct a cost-benefit analysis to incorporate into the rule score.
Management’s Response: The Director,
Reporting Compliance, W&I Division, will analyze Fiscal Year (FY) 2003
Dependent Database closed case data and attempt to group returns by rules
broken and assign costs to those groups.
2.
Incorporate a cost-benefit analysis into the Dependent Database
Risk-Based Scoring Model planned for implementation in January 2004.
Management’s Response: The Director,
Reporting Compliance, W&I Division, will incorporate a cost-benefit
analysis into the Dependent Database selection process; however, IRS management
stated that it would be unable to do so until January 2005.
The IRS did not agree with our assessment that an
additional $20.9 million in overclaims could have been protected. The IRS stated it needs to conduct a
comprehensive analysis using complete FY 2003 data, which are not yet
available, to make this determination.
Office of Audit Comment: We agree that we did not use complete FY
2003 data to compute the $20.9 million in overclaims that could have been
protected. Complete data were not available
at the time of our review. However, our
calculation was based on a significant portion of the year’s data. Our estimate was also calculated using cost
and examination outcome data provided by the IRS. Therefore, we believe our calculation of the additional
overclaims that could be protected is reasonable.
Appendix I
Detailed Objective, Scope,
and Methodology
The overall objective of this review was to determine whether the Internal Revenue Service’s (IRS) process for selecting Earned Income Tax Credit (EITC) cases for examination is providing the best effect on compliance and fairness to taxpayers. Specifically, we determined if the Dependent Database examination case selection process for EITC returns results in the greatest benefit at the least cost (cost-benefit) while ensuring taxpayers are treated fairly and uniformly under the law.
We conducted the following tests to accomplish the objective:
I.
To determine if
the Dependent Database examination selection process focuses on the goals and
strategies established by the EITC Examination Program, we identified the IRS’
overall goals for the EITC Examination Program. We also interviewed personnel in the Office of Compliance
and the EITC Program Office in the Wage and Investment Division Headquarters
and the Office of Compliance in the Small Business/Self-Employed Division to determine the Dependent Database
examination case selection program’s goals.
II.
To determine if
the IRS has an effective process to evaluate the results of its Dependent
Database examination selection process and make necessary adjustments to the
process, we identified and reviewed analyses performed by the IRS to evaluate
the results of EITC examinations. We
also determined how the IRS calculates program measures and results, including
the no-change rate and EITC overclaims protected. We determined the process used to implement changes to the
Dependent Database examination selection process.
III.
To determine if
the Dependent Database examination selection process ensures resources are
being used to provide a balanced compliance program (i.e., the greatest
cost-benefit while ensuring taxpayers are treated fairly and uniformly under
the law), we:
A.
Determined
whether the Dependent Database examination selection process could provide a
greater cost-benefit by analyzing the Tax Year (TY) 2001 data for EITC
examination closed cases on the Dependent Database. We obtained related information from the copy of the Audit
Information Management System at the Treasury Inspector General for Tax
Administration Data Center Warehouse.
We stratified the closed cases by various rule groupings and type of
income claimed and determined how the IRS calculates the cost of conducting
Dependent Database EITC examinations.
We computed the cost-benefit for each group of returns and performed
analyses to vary the number of returns selected per group to optimize the
benefit.
B.
Determined
whether the Dependent Database examination selection process is ensuring
taxpayers are treated fairly and uniformly under the law by analyzing and
comparing the characteristics of taxpayers selected for examination to the
characteristics of the overall population of taxpayers that claimed the EITC
for TYs 2000 and 2001.
Appendix II
Major Contributors to This Report
Michael R. Phillips, Assistant Inspector
General for Audit (Wage and Investment Income Programs)
Augusta
R. Cook, Director
Deann
L. Baiza, Audit Manager
Areta
G. Heard, Senior Auditor
Doris
J. Hynes, Senior Auditor
Alan
Lund, Senior Auditor
Robert J. Carpenter, Senior Information Technology Specialist
Debra Morgan, Information Technology Specialist
Appendix III
Commissioner C
Office of the Commissioner – Attn: Chief of Staff C
Deputy Commissioner for Services and Enforcement SE
Commissioner, Small Business/Self-Employed Division SE:S
Deputy Commissioner, Wage and Investment Division SE:W
Acting Deputy Commissioner, Small Business/Self-Employed Division SE:S
Director, Compliance, Small Business/Self-Employed Division SE:S:C
Director,
Compliance, Wage and Investment Division
SE:W:CP
Director, Earned
Income Tax Credit, Wage and Investment Division SE:W:EITC
Director, Strategy
and Finance, Wage and Investment Division
SE:W:S
Earned Income Tax
Credit Program Manager, Wage and Investment Division SE:W:EITC
Director,
Communications and Liaison, Small Business/Self-Employed Division SE:S:MS:CL
Chief Counsel CC
National Taxpayer Advocate
TA
Director, Office of Legislative Affairs CL:LA
Director, Office of
Program Evaluation and Risk Analysis
RAS:O
Office of
Management Controls OS:CFO:AR:M
Audit
Liaisons:
GAO/TIGTA Liaison, Wage and Investment
Division SE:W:S:PA
Chief, Customer Liaison, Small Business/Self-Employed Division SE:S:COM
Appendix IV
This appendix presents detailed information on the measurable impact that our recommended corrective actions will have on tax administration. This benefit will be incorporated into our Semiannual Report to the Congress.
Type and Value of Outcome Measure:
· Funds Put to Better Use – Potential; $20.9 million additional Earned Income Tax Credit (EITC) overclaims protected for Tax Year 2001 returns (see page 6).
Methodology Used to Measure the Reported Benefit:
This outcome represents the projected additional EITC overclaims protected if the Internal Revenue Service (IRS) incorporated cost-benefit data into its evaluation of the selection of returns claiming the EITC using the Dependent Database.
The IRS used the Dependent Database scoring and selection program to select 168,290 returns for EITC pre-refund examinations from January through August 2002, protecting an estimated $419.6 million in EITC overclaims.
By incorporating cost-benefit into its selection criteria, the Dependent Database scoring and selection program’s selection of 168,290 returns for examination could have protected an estimated $440.5 million in EITC overclaims ($20.9 million more in estimated EITC overclaims) during the same processing period.
To develop a cost-benefit selection model using return on investment (ROI) analysis:
· A total of 75,165 closed EITC examination cases were reviewed:
- The examined returns were stratified into groups based on Dependent Database rule(s) broken.
- The ROI per return group was computed by dividing the EITC overclaims protected in each group by the cost to examine the group. An average examination cost of $185.32 provided by the EITC Program Office was used in this computation.
· The ROI per return group was compared to a computed overall ROI group average to compute a relative ROI for each group.
· The cost-benefit selection model used the ROI per group in assigning a desired selection rate per group (i.e., groups with a high ROI were assigned a large selection rate and groups with a low ROI were assigned a low selection rate), resulting in returns from groups with a relatively high ROI being selected more frequently.
Not all 168,290 returns selected for pre-refund EITC examinations by the Dependent Database had been completed at the time of our review. To estimate the total amount of overclaims protected ($419.6 million) by the Dependent Database selection of returns from January through August 2002, the per group ROI obtained from our closed case analysis was applied using the following computations:
· Total cost to examine per group was computed as the number of examinations (per group) multiplied by the average cost to examine ($185.32).
· Estimated EITC overclaims protected per group was computed as the total cost to examine per group multiplied by the ROI per group.
· Total estimated EITC overclaims protected was computed as the sum of the estimated EITC overclaims protected per group.
Using the cost-benefit model, the Dependent Database selection of returns (168,290) was redistributed to maximize EITC overclaims protected. The primary emphasis was selecting returns from groups with a greater ROI. This selection resulted in estimated EITC overclaims protected of $440.5 million and was calculated using the same computations as above.
Appendix VI provides a more detailed explanation of the cost-benefit model that was developed using ROI analysis.
Appendix V
The Dependent Database system was developed to add child custody and support data, acquired from the Department of Health and Human Services (HHS), to the processing of individual tax returns. The Internal Revenue Service (IRS) uses the Dependent Database scoring program to identify and select for examination those tax returns with possible erroneous Earned Income Tax Credit (EITC) claims. Between January and August 2002, the Dependent Database scoring program identified approximately 2.9 million returns for possible pre-refund examination. Of those, approximately 168,000 were selected for examination.
During initial tax return processing, all tax returns that have claimed at least one EITC-qualifying child or dependent child are evaluated by this system. Using several data sources, the system analyzes the return for specific criteria. These criteria are based on characteristics that would indicate the taxpayer might not be eligible for the EITC.
There are 25 different sets of criteria used in the Dependent Database scoring program. A numeric value is assigned to each set of criteria, and each of the 25 sets of criteria is applied to every tax return. The Dependent Database produces an overall score for the return based on the outcome of this analysis.
After all tax returns are scored, certain types and quantities of returns are selected for pre-refund examinations based on IRS resources available. If a return is selected for examination, the taxpayer’s refund is “frozen” until the examination is completed and all questionable information is verified.
Internal and external data used in the Dependent Database scoring program include:
· Generalized Mainline Framework 15 – Primary file used in the Dependent Database that includes United States (U.S.) Individual Income Tax Return (Form 1040 series) information for each taxpayer.
· Federal Case Registry of Child Support Orders – Database created using information reported from state agencies and the District of Columbia to the HHS, including the identity of the custodial parent, the non-custodial parent, and any person who may be recognized as a parent, such as a legal guardian.
· Kidlink – Database containing information about a child’s mother and father as reported to the Social Security Administration (SSA).
· DM1 – Database containing vital statistics for the entire U.S. population as reported to the SSA, such as the date of birth or date of death of an individual.
· DUPTIN – Database containing Social Security Numbers (SSN) and their usage in the IRS’ tax return processing system.
· National Account Profile – Database containing taxpayer-identifying information including a taxpayer’s SSN, name and address, and information pertaining to the taxpayer’s spouse.
· Individual Returns Transaction File – File that contains tax return information that has completed the IRS’ tax return processing system.
· Duplicate Direct Deposit – Database containing bank account information that associates all taxpayers that used the account for a direct deposit refund.
· Individual Master File On-Line – Files containing the on-line version of taxpayer information and tax return information.
While the primary focus of the Dependent Database process is to verify whether taxpayers that claim children to receive the EITC are meeting residency and/or relationship requirements, other issues are also examined. Those issues include:
· Duplicate claims of children (for the EITC or dependent purposes) by two or more taxpayers.
· Invalid filing status for the EITC.
·
Deceased qualifying child or dependent.
Appendix VI
We conducted a cost-benefit analysis using a standard return on investment (ROI) analysis. Standard accounting procedures define ROI as the income received divided by the investment made. For purposes of this analysis, we defined:
· Income received as the amount of Earned Income Tax Credit (EITC) overclaimed by the taxpayer that was disallowed as a result of the examination. (Our analysis did not consider other tax and/or credit adjustments made in the same examinations.)
· Investment made as the cost of conducting an examination.
We performed this ROI analysis to determine if the Internal
Revenue Service’s (IRS) Dependent Database examination case selection process ensures resources are being used to
provide the greatest ROI possible. Our
analysis included examinations of returns for Tax Year (TY) 2001 that
had begun between January and August 2002 and had been completed by November 2,
2002.
The details of our analysis follow.
Of
all returns selected for examination by August 31, 2002 (168,290), there were 75,165
examinations that were completed (Audit Information Management System disposal
code 01-13) by November 2, 2002. The
Audit Information Management System is an automated computer system used for
examination case workload management.
4. Stratified the returns selected for examination by rule broken or by groups of rules broken. Returns were categorized into 1 of 31 groups based on the types of rules broken (issues) and the data used to score the returns – Federal Case Registry (FCR), Dependent Database (DDb), and Electronic Fraud Detection System (EFDS). The groups used were:
Multiple FCR, DDb, and EFDS rules broken.
Multiple FCR rules broken.
Multiple DDb rules
broken.
Multiple FCR and DDb rules broken.
Multiple FCR and EFDS rules broken.
Multiple DDb and EFDS rules broken.
Each
individual rule broken (25 different rules).
5. Computed the ROI for each group of closed examinations (75,165) using the following method:
a) The total examination cost to conduct examinations for a group was calculated as the count of examinations per group multiplied by $185.32 (the average cost of EITC examinations provided by the EITC Program Office).
b) The EITC overclaims protected by group was calculated by summing the Dependent Database Select Table “EITC change” field for each return in the group.
c) The ROI per group was calculated as EITC overclaims protected divided by the total examination cost.
Step 2:
Projected total EITC overclaims protected on 75,165 TY 2001 examinations
closed by November 2, 2002, to the total number of Dependent Database
examinations (168,290) selected between January and August 2002 based on the
ROI per strata obtained in Step 1.
Assumption: The results of the examinations closed after November 2, 2002, would not vary significantly from those closed prior to November 2, 2002 (i.e., similar EITC overclaim protected per examination).
1. Applied the ROI per group computed in Step 1.5 above to all groups in the Dependent Database Select Table (168,290 stratified in Step 1.4) because not all 168,290 returns selected for examination by August 31, 2002, were closed by November 2, 2002.
2. Calculated the projected total examination cost for each group by multiplying $185.32 times the count of examinations per group.
3. Calculated the projected EITC overclaims protected for each group by applying the ROI for each group to the total examination cost for each group (i.e., projected total examination cost for each group multiplied by the ROI for each group).
4. Computed the total projected EITC overclaims protected by summing the projected EITC overclaims protected for each group. Based on the ROI per group, the IRS model used to select TY 2001 EITC returns for examination (168,290 returns) would result in approximately $419,617,420 in EITC overclaims protected.
Step 3: Selected the TY 2001 Dependent Database examination inventory (selected prior to August 31, 2002) based on the relative ROI for the purposes of maximizing the projected EITC overclaims protected.
This analysis was conducted to determine the change in EITC overclaims protected if examination case selection was based on relative ROI – selecting more returns from groups with larger ROIs and fewer returns from groups with smaller ROIs.
Because we were not able to rescore TY 2001 returns to incorporate ROI analysis into the point-based Dependent Database examination selection process, we opted to use an alternate percentage-based method to select returns for examination. We are not advocating that the IRS adopt this method; it is intended as an illustration of how incorporating ROI could change the amount of EITC overclaims protected using the same number of resources.
Assumptions:
· The resource level remains the same so only 168,290 examinations can be selected.
· Each rule must have some amount of coverage.
· The results of the examinations closed after November 2, 2002, would not vary significantly from those closed prior to November 2, 2002 (similar EITC overclaim protected per examination).
Category Relative ROI Selection Rate
1 – High 2.26 30.23 percent
2 – Adjusted** 2.00 to 2.25 Various based on available volumes
3 – Above Average 1.41 to 1.99 10.00 percent
4 – Mid-Average 1.01 to 1.40 0.5 percent
5 – Low Average 0.75 to 1.00 0.1 percent
6 – Low below .075 0.05 percent
** Some rule groups with high ROIs (category 2) that should have had a corresponding high selection rate had to be adjusted down because the volume of returns in the Score Table which were eligible to be selected was insufficient.
4. Applied the selection rate from the categories identified in Step 3.3 to the total workload of 168,290 examinations for the filing season as a whole. For example, the multiple FCR and EFDS rules group had a relative ROI of 2.26, which placed it in the high category with a selection rate of 30 percent.
Appendix VII
The response was removed due to its size. To see the response, please go to the Adobe PDF version of the report on the TIGTA Public Web Page.