Can a simple educational letter to taxpayers who appear to have erroneously claimed the earned income tax credit (EITC) actually avert future noncompliance? Based on recent TAS research studies, the answer appears to be yes.

As readers of this blog already know, the EITC is a refundable credit designed to provide financial support to low income working taxpayers, especially those with children in the household. Because it focuses on household composition, the administration of the credit is very complex. While the IRS can generally establish the age of the child from various government databases, and sometimes the parent-child relationship, it cannot easily establish other relationships nor can it independently determine with whom the child lived for over half the year, as the law requires.

Moreover, as I’ve discussed in an earlier report and recommendation to Congress, evolving family structures and the sheer complexity of the law cause taxpayers to make mistakes (or cheat) and provide opportunities for careless or unscrupulous preparers to file inaccurate (and even fraudulent) returns. Accordingly, the Government Accountability Office (GAO) has named the EITC as one of the most significant improper payments under the Improper Payments Elimination and Recovery Act of 2010. Congress continues to focus its attention on IRS efforts to reduce these improper payments.

Given this level of congressional and IRS concern, we wondered whether a simple written communication sent before the commencement of the filing season to past EITC claimants might change their compliance behavior going forward. We first explored this possibility in 2016 and reported our findings here. As the report explains, in January 2016 we sent a letter signed by me to a representative sample of taxpayers who claimed EITC on their 2014 returns, apparently in error. (The IRS screens EITC returns through the Dependent Database and identifies many more problematic returns than it has the resources to audit.) The letter explained that although the taxpayer’s return was not being audited, the IRS believed EITC had been claimed in error for one of three reasons: the relationship requirement was not met, the residency requirement was not met, or another taxpayer claimed EITC with respect to the same qualifying child.

In plain language, the letter set out the rules for meeting each of these three requirements, and identified the specific requirement that did not appear to have been met in that taxpayer’s case. The purpose of the letter was “to help you understand the rules for claiming the Earned Income Tax Credit (EITC) so you don’t make a mistake on your 2015 Form 1040.” I also suggested that the taxpayer share the letter with his or her return preparer, if the taxpayer uses one. The envelope for the letter was marked “Important Tax Information” in red, to increase the chances that the taxpayers, who might be expecting information they needed to file their returns to arrive by mail, would be more likely to open and read it.

We then compared the level of compliance of the 2015 returns filed by taxpayers who received the TAS letter to two other representative samples of similar taxpayers who claimed EITC, apparently in error, on their 2014 returns:  those who were not audited and did not receive a TAS letter (the control group); and those who were audited.

Among the most interesting findings, we discovered that the TAS letter averted noncompliance where the apparent error was that the relationship test appeared not to have been met. The reason is, taxpayers who received the TAS letter were less likely to repeat the error, on their 2015 returns, of claiming EITC when they did not meet the relationship test. This outcome outweighed the fact that some taxpayers who received the TAS letter appeared to erroneously claim EITC for a different reason (i.e., some taxpayers met the relationship test, but the residency test appeared not to have been met, or there was a duplicate claim). According to our projections, sending the TAS letter to all taxpayers whose 2014 returns appeared to claim EITC erroneously because the relationship test was not met would have averted about $47 million of erroneous EITC claims.

We carried out a similar study in 2017, fine tuning the letter in light of what we had learned from the 2016 study. One thing we had noticed is that where the residency test appeared not to have been met, taxpayers who received the TAS letter were less likely to repeat that error than taxpayers in the control group, but this result was not statistically significant. We thought this could be because household arrangements as they relate to EITC rules might be too complex to explain in a simple letter. So, for the 2017 study, we identified a separate group of taxpayers who claimed EITC on their 2015 returns, but appeared to not meet the residency test. We sent these taxpayers a letter that was identical to the letter sent to the other groups of taxpayers, except it included this sentence: “If you would like to talk with a Taxpayer Advocate Service employee about your eligibility for the EITC, you can call [toll-free number] for assistance.”

Another insight we gained from the earlier 2016 study was that where the apparent error was that a duplicate claim existed, the TAS letter impeded taxpayers from filing returns on which they claimed EITC, compared to the control group. We thought this could be because taxpayers were interpreting our letter to mean that they would not qualify for EITC at all, when they might actually qualify for the childless-worker EITC. So, for the 2017 study, we added a reminder of the childless-worker EITC to the letters we sent to all groups of taxpayers.

We sent the second round of letters in January 2017, again using an envelope marked “Important Tax Information” in red. We again monitored taxpayers’ compliance levels, this time with respect to their 2016 returns. The 2017 study, like the 2016 study, found that where the apparent error was that the relationship test had not been met, the TAS letter averted noncompliance, but the dynamics were slightly different. In the 2017 study, taxpayers who received the TAS letter because they appeared to not meet the relationship test were not only statistically less likely to repeat their error (the same outcome as in the 2016 study), but they were also statistically less likely to make any error in claiming EITC on their 2016 returns.

According to our projections from the 2017 study, sending the TAS letter to all taxpayers whose 2015 returns appeared to claim EITC erroneously because they didn’t meet the relationship test would have averted nearly $53 million of erroneous EITC claims. (For additional perspective on the potential savings, you can read here about the IRS’s private debt collection initiative, which netted only about $3 million for the Treasury in the six months or so it operated during fiscal year 2017, after commissions and amounts retained by the IRS are taken into account.)

Providing an extra help phone number for taxpayers who appeared not to meet the residency test also turned out to be effective in preventing noncompliance. According to our projections, more than $44 million of erroneous EITC claims would have been averted by sending the letter with the extra help phone number to all taxpayers whose 2015 returns appeared to claim EITC erroneously because the residency test was not met. Just sending the letter had this effect. Of the 967 taxpayers who received the letter with the extra help phone number, only 35 actually called and spoke with a TAS employee. I think this shows the compliance impact of the legitimacy of government – if taxpayers perceive the agency is willing to help, they may be more willing to comply. I contrast this approach with the negative compliance impact of restrictive policies, such as the “appointment only” basis for getting assistance at Taxpayer Assistance Centers, or the IRS’s previous refusal to answer tax law questions other than during the filing season (see my recent discussion of these practices here). Also, taxpayers who received the letter with the extra help phone number were the only ones who also claimed the childless-worker EITC at an increased rate compared to the previous year.

We’re planning to resume the study in 2019, refining our approach in light of the 2016 and 2017 study findings and following up with focus groups of taxpayers who received the letter. We know that the TAS letter is particularly effective when it includes an extra help phone number, so we plan to include the extra help phone number not only in letters to taxpayers who appeared not to have met the residency test, but also in letters to some taxpayers who appeared not to have met the relationship test. Even without the extra help phone number, the TAS letter averts noncompliance among those who appeared not to have met the relationship test, so including the extra help phone number may further enhance compliance among these taxpayers. Because neither the 2016 or 2017 study indicated that the TAS letter averted noncompliance when the apparent error was that a duplicate claim existed, the letter we plan to send taxpayers who appeared to make this error will include the extra help phone number. We’ll see if offering this additional resource turns things around for them the same way it did for taxpayers who appeared to not meet the residency requirement.

To recap:

• The 2016 letter would have averted $47 million in erroneous EITC claims attributable to not meeting the relationship test;
• The 2017 letter would have:
  • Averted $53 million in erroneous EITC claims attributable to not meeting the relationship test;
  • Averted $44 million in erroneous EITC claims attributable to not meeting the residency test, if the letter also offered an extra help line; and
  • Increased legitimate claims for the childless worker credit, if the letter also offered an extra help line.

In the meantime, in both the 2016 and 2017 studies, I recommended that the IRS send letters to taxpayers similar to the ones I wrote. I made the same recommendation in my 2017 Annual Report to Congress where I identified the IRS’s inadequate use of research findings about the impact of taxpayer education on compliance with EITC rules as a Most Serious Problem facing taxpayers. I’ll report on how the IRS responded to the recommendation in my 2019 Objectives Report to Congress.

Have a question? Contact Nina Olson and the National Taxpayer Advocate Team.

Your comments are always welcome!