IRS Approved $2.3 Billion in Fraudulent Alimony Deductions

$1.7 billion in potential lost revenue

The U.S. Treasury building / AP

The Internal Revenue Service (IRS) authorized $2.3 billion in alimony deductions for divorced persons last year that did not match with their ex-spouses’ income, according to an audit by the Treasury Inspector General for Tax Administration (TIGTA).

The audit, released last week, found that nearly half of all alimony deductions in 2010 were improper.

"In Tax Year 2010, a total of 567,887 taxpayers claimed alimony deductions totaling more than $10 billion," TIGTA said. "An alimony income reporting discrepancy occurs when individuals claim deductions for alimony which they did not pay or individuals do not report alimony income they received."

Persons who pay alimony are allowed to deduct their payments on their tax return to reduce their tax burden. However, the payments must be accounted as added income for the recipient of the alimony.

TIGTA examined 567,887 returns with an alimony deduction claim in 2010, and found that 266,190—or 47 percent—had income from claimed alimony deductions that were not reported or were inconsistent.

"There is a discrepancy of more than $2.3 billion in deductions claimed without corresponding income reported," the audit said.

TIGTA noted that the IRS does not have a system in place to address improper alimony claims.

"Apart from examining a small number of tax returns, the IRS generally has no processes or procedures to address this substantial compliance gap," the audit said.

In addition, the IRS does not "ensure that individuals provide a valid recipient Taxpayer Identification Number (TIN) when claiming an alimony deduction as required." A TIN is an Employer Identification Number, a Social Security Number, or an Individual TIN, which is used to process tax filings.

The audit found 6,500 tax returns claimed $95.7 million in "potentially erroneous" alimony deductions because the IRS "did not identify that the recipient TIN was missing or invalid."

If a claim is missing a TIN, the agency is required to assess a $50 penalty. The audit found that the IRS only assessed penalties in 20 of the 6,500 cases, or 0.3 percent.

"In addition, for those assessed, the amount was $5 instead of $50 (the IRS could not provide an explanation as to why the $5 was assessed on these 20 accounts)," TIGTA said.

By not assessing penalties the IRS lost $324,900, and TIGTA expects the agency to lose $1.6 million in penalties over the next five years.

The IRS blamed the error on "incorrect processing instructions."

The tax collecting agency also "does not possess the authority to deny the alimony deduction outside of deficiency procedures," making it difficult to bridge the gap in alimony claims and actual alimony income.

However, the "lack of authority to deny an alimony deduction claim without conducting an examination does not preclude the IRS from notifying taxpayers that they are not compliant with the alimony reporting requirements," TIGTA noted.

In fact, the IRS examines "very few" tax returns that have a reporting discrepancy. The IRS selected only 10,870 returns for examination in 2010.

TIGTA recommended the IRS develop a strategy to address the alimony compliance gap. The IRS agreed, but said they currently have procedures in place and will "continue to review and improve its strategy as warranted."

The IRS also disputed TIGTA’s assertion that the lack of oversight of alimony claims would result in $1.7 billion in potential lost revenue over five years. The agency said it does not have the ability to audit every tax return with an alimony claim.

"However, we did not recommend that the IRS examine more tax returns," TIGTA said. "We recommended that the IRS develop a strategy, including the use of less costly non-examination processes, to more adequately address the alimony reporting gap."

The audit urged the IRS to issue more "soft notices," or letters to alimony claimants to notify them that their claim does not match with their ex-spouses income, or if it was missing or used an invalid TIN.

A study conducted by the IRS in 2009 found that 92 percent of individuals who had received notices "changed their filing behavior in the subsequent tax year."

"Such a strategy should ensure the most efficient use of resources to achieve the most significant improvement in taxpayer compliance possible," TIGTA said. "Our outcome measure reflects the potential unreported revenue we believe the IRS could address by developing such a strategy."