A key component of President Obama's proposed tax reform has led to massive fraud and collection losses for the federal government, according to a new IRS report.
The Treasury Inspector General for Tax Administration (TIGTA) found that millions of taxpayers wrongfully claimed education deductions to cut into their tax bill in 2012. The potential fraudsters have exploited lax oversight to take advantage of Obama's $2,500 American Opportunity Tax Credit (AOTC), which was initially passed in the so-called stimulus, as well as President Bill Clinton's Hope and Lifetime Learning credits.
More than 3 million tax filers have erroneously claimed these credits, costing the government more than $5 billion.
"The IRS still does not have effective processes to identify erroneous claims for education credits," Inspector General J. Russell George said in a release.
Up to 1 million tax filers falsely claimed the AOTC, leading to a potential loss of $1.3 billion, according to the report.
"419,827 taxpayers received more than $650 million for students who were used to claim the AOTC for more than four tax years. 427,345 taxpayers received approximately $662 million in AOTCs for students who attended school less than half-time," the report said.
Despite these misgivings and the high potential for fraud, President Obama has made the AOTC a central part of his tax reform plan. The credit passed in 2009 as part of the so-called stimulus plan. It was set to expire in 2010, but Obama extended it to 2017. He is now seeking to make it permanent and hopes to consolidate several other student tax credits into the AOTC.
"The President’s plan will consolidate six overlapping education provisions into just two, while improving the American Opportunity Tax Credit to provide more students up to $2,500 each year over five years as they work toward a college degree—cutting taxes for 8.5 million families and students and simplifying taxes for the more than 25 million families and students that claim education tax benefits," the White House said.
Numerous filers have claimed the credit for students who did not graduate in four years, students who went to non-accredited institutions, and those not attending school at least half-time. The IRS has known about this problem for many years after prior TIGTA audits, but has failed to properly correct the loopholes and enhance oversight, according to the inspector general.
"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," George said.
TIGTA’s office issued five recommendations to strengthen oversight of the problem. However, the IRS rejected three of these measures, including suggestions to work with the Department of Education to root out false claims, to verify the authenticity of claims before issuing refunds, and to filter out those who have already claimed the credit for four years.
The agency agreed that legislation should be proposed to shore up the system.
TIGTA also found that 250 inmates in correctional facilities had claimed the credit as students; the IRS agreed to filter out such claims for verification in the future.
Debra Holland, commissioner of the IRS Wage and Investment Division, responded to TIGTA findings by saying that the agency did not have authorization to use third-party databases, such as those belonging to the Department of Education. She said in a memo that the agency had already implemented significant oversight procedures for rooting out fraud and that TIGTA’s findings suffered from selection bias.
"We disagree with the Treasury Inspector General for Tax Administration’s (TIGTA) finding that the IRS does not have effective procedures," she wrote. "To the contrary … IRS identified 1.8 million questionable returns for potential audit."
Michael McKenney, the deputy inspector general for audit, acknowledged these findings in a memo sent to the IRS, but said the agency still deserved a failing grade for its oversight.
"While the IRS has developed processes to identify erroneous education credit claims … those processes only identified 50 percent of the more than 3.6 million questionable education credit claims we identified during our review. As such, we believe the conclusion is accurate that the IRS’s processes are not effective in identifying erroneous education credit claims," he said.
The White House has its own plan for addressing the potential fraud by legalizing the abuses identified by TIGTA.
"Currently students must be at least half-time to qualify for the AOTC, and families can claim the credit for no more than four years. Under the President’s plan, part- time students would be eligible for a $1,250 AOTC (up to $750 refundable) and all eligible students would be able to claim the AOTC for up to five years," the White House said in its tax plan.