IRS Approves Billions in Iffy Education Tax Credit Claims, Watchdog Says

The Internal Revenue Service approved $5.6 billion in questionable education tax credits on the returns of 3.6 million taxpayers, a sign that the tax agency’s ongoing efforts to curb improper payments needs bolstering, according to a watchdog.

An IRS official disputed some of the findings.

"The IRS still does not have effective processes to identify erroneous claims for education credits,” said J. Russell George, Treasury Inspector General for Tax Administration, in a Tuesday statement accompanying the report dated March 27.  “Although the IRS has taken steps to address some of our recommendations, many of the deficiencies TIGTA previously identified still exist. As a result, taxpayers continue to receive billions of dollars in potentially erroneous education credits."

The higher education tax credits in question date back to the 1997 Taxpayer Relief Act, which established the Hope Credit and Lifetime Learning Credit. The 2009 American Recovery and Reinvestment Act temporarily replaced the Hope Credit with a refundable tax credit known as the American Opportunity Tax Credit. Though initially set to expire at the end of 2010, it was extended through 2017.

After analyzing education credits claimed and received on returns for the 2012 tax year, TIGTA estimated that more than 3.6 million taxpayers (reflecting more than 3.8 million students) received more than $5.6 billion in potentially erroneous education credits ($2.5 billion in refundable credits and $3.1 billion in nonrefundable credits).

Specifically, more than 2 million taxpayers received more than $3.2 billion in education credits for students without filing the required tuition documents (Form 1098-T). More than 1.6 million taxpayers received some $2.5 billion in education credits for students attending ineligible institutions. An estimated 419,827 taxpayers received more than $650 million for students who were used to claim the American Opportunity Tax Credit for more than four tax years, while 427,345 taxpayers received about $662 million in opportunity credits for students who attended school less than half-time.

TIGTA made five recommendations to the IRS for weeding out ineligible claims, among them that it work with the Treasury Department on “a legislative proposal to move the required filing date for Forms 1098-T to Jan. 31 so that this information can be used at the time tax returns are processed to help identify improper education credit claims.” The IG also recommended that IRS tap into the Education Department’s Postsecondary Education Participants System database.

The IRS noted that it’s 2015 and 2016 budget requests to Congress included provisions for changing the tuition form filing deadline to January, but Congress has not yet acted. The tax agency also agreed with another recommendation that it modify software filters to identify erroneous education credit claims. But the tax agency did not agree to the other three recommendations, prompting TIGTA’s concern.

Debra Holland, commissioner of the IRS’ Wage and Investment Division, said in a March 27 letter to TIGTA that the agency had blocked 1.8 million returns with questionable claims. She said some external checks on data are already in place and that IRS, though it would be interested, could not coordinate with the Education Department because “under existing statutory authority, the IRS cannot use this third-party information to correct a tax return during processing.”

The IRS also challenged the methodology TIGTA auditors used to estimate $20.1 billion in projected revenue and cost savings through system improvements, citing a “bias introduced that caused an overstatement of results.”

The watchdog noted that the IRS has included a legislative proposal in its budget requests for fiscal 2013, 2014 and 2015 to obtain authority to disallow tax benefit claims when reliable third-party data indicate the claim is erroneous. “This authority would enable the IRS to systemically deny all education credit claims for which third-party data show the claim is erroneous, adjust the tax return and notify the taxpayer of the adjustment,” TIGTA wrote. “In addition, the IRS’ ability to detect and prevent erroneous education credit claims will continue to improve as it identifies additional sources of reliable third-party data with which to verify taxpayers’ claims at the time tax returns are processed and prior to claims being paid.”

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