Treasury Proposes Tighter Oversight of Refundable Tax Credits

The Treasury Department is proposing tighter eligibility rules for refundable tax credits, drawing opposition from critics who warn that the change could affect some legal immigrants and families with U.S. citizen children. The criticism comes despite a long record of improper payments and eligibility errors in refundable tax credit programs.

Treasury's proposal would classify the refundable portions of the Earned Income Tax Credit, Child Tax Credit, American Opportunity Tax Credit, and adoption tax credit as federal public benefits. Recipients of those payments would generally need to be U.S. citizens, U.S. nationals, or qualified aliens under federal law.

The Tax Policy Center has criticized the proposal, arguing that it could exclude some legally present immigrants who currently qualify for the credits. Yet the organization has previously documented the significant payment problems that make stronger verification necessary.

The IRS has estimated that between 22 percent and 26 percent of Earned Income Tax Credit payments were improper, according to the Tax Policy Center. The organization notes that improper payments can result from both fraud and taxpayer mistakes, with the complexity of the credit contributing to errors.

Treasury should make sure eligible taxpayers are not improperly denied benefits. The federal government still has a responsibility to prevent taxpayer dollars from going to people who do not qualify.

Refundable Credits Have a Documented Error Problem

Federal tax law already uses immigration status, residency, and taxpayer identification requirements to determine eligibility for refundable credits.

The Earned Income Tax Credit generally requires taxpayers, spouses filing jointly, and qualifying children to have work-authorized Social Security numbers. Social Security number requirements apply to the Child Tax Credit and American Opportunity Tax Credit as well. Nonresident aliens face additional restrictions on several of the credits covered by Treasury's proposal.

Treasury is proposing to apply the eligibility requirements governing federal public benefits to the refundable portion of these credits, adding another check before federal money is paid.

Past experience shows why verification cannot be an afterthought. A separate IRS study cited by the Tax Policy Center estimated that between 28.5 percent and 39.1 percent of Earned Income Tax Credit dollars claimed from 2006 through 2008 were overclaims, totaling between $14 billion and $19.3 billion. The largest source of those errors involved whether children met the requirements to be considered qualifying children.

Those figures do not mean every improper payment was fraudulent. The Tax Policy Center notes that only a minority of improper payments identified in earlier research resulted from fraud, while complicated eligibility rules can lead taxpayers to make mistakes.

The distinction between fraud and error should affect how the IRS responds to individual cases. It should not lessen the need to verify eligibility before federal money goes out the door.

Better Verification Has Worked Before

The federal government has already tightened refundable tax credit verification when weaknesses became apparent.

Congress previously delayed refunds for taxpayers claiming the Earned Income Tax Credit or additional Child Tax Credit until the IRS had more time to verify claims. Employers were also required to provide wage information to the IRS earlier. According to the Tax Policy Center, those changes allowed the IRS to verify claims earlier and protected more federal revenue than the previous system.

Treasury now faces another verification problem. The Tax Policy Center argues that the IRS does not currently collect all of the information it would need to determine whether every taxpayer meets the immigration requirements in the proposed rule.

Treasury should address that problem before implementation. The IRS needs a process capable of identifying ineligible claims without creating unnecessary delays or erroneous denials for taxpayers who qualify.

Weak verification is not a solution. If eligibility depends on information the IRS does not currently have, Treasury should establish a reliable way to obtain and verify it.

Federal Benefits Need Enforceable Rules

Refundable tax credits can exceed a taxpayer's income tax liability, with the remaining amount paid by the federal government. Once a credit results in a federal payment, taxpayers have a legitimate interest in knowing that eligibility requirements are being enforced.

Similar fights have emerged when federal agencies strengthen oversight of health care and welfare programs. Critics often focus on the possibility that additional verification could burden eligible beneficiaries. Agencies should minimize those burdens, but the possibility of administrative error cannot justify leaving known weaknesses in place.

The record on refundable tax credits shows what happens when the government lacks the information needed to verify claims before payments are made. Treasury should use the rulemaking process to improve those safeguards while ensuring that eligible taxpayers continue to receive the benefits available under federal law.

CFE Takeaway

Refundable tax credits have a documented history of improper payments and eligibility errors. The Tax Policy Center itself has reported substantial error rates in the Earned Income Tax Credit and has acknowledged that earlier verification reforms helped protect federal revenue.

Treasury should make its new eligibility rules accurate and workable, but stronger oversight is warranted. Federal benefits need enforceable eligibility standards, and taxpayers should expect the government to verify those standards before sending out federal money.