Did you know the IRS has the authority to ban a taxpayer from claiming the Earned Income Tax Credit (EITC), the Child Tax Credit (CTC), the American Opportunity Tax Credit (AOTC) and the credit for other dependents (ODC) for two years if the IRS determines that the taxpayer improperly claimed the credit “due to reckless or intentional disregard of rules and regulations”? The ban can last for ten years if the credit was claimed fraudulently. The IRS determines whether to propose a ban as part of its audit of the taxpayer’s tax return. The Internal Revenue Manual (IRM) procedures for imposing bans include IRM 4.19.14.7.1, (12-11-2019), 2/10 Year Ban – Correspondence Guidelines for Examination Technicians (CET).

What taxpayers need to know to support the claimed credit

The rules for claiming these refundable credits are similar – but not the same – and the complexity of the rules causes taxpayers to erroneously claim the credits.  Here are a few rules:

• Allowable EITC and CTC is a function of a taxpayer’s earned income or “modified adjusted gross income” and the number of “qualifying children” in the household.
• A “qualifying child” is a person who, among other things, meets age requirements, bears a specified relationship to the taxpayer, and has the same principal residence as the taxpayer for more than half the year.
• The EITC and CTC age requirements differ, and disabled dependents (regardless of age) may meet the definition of a qualifying child for the EITC but not for the CTC.
• The amount of allowable AOTC:
  • is a function of “modified adjusted gross income” (like the CTC); and
  • is only partially refundable (like the CTC but unlike the EITC).
• The ODC is available for certain “dependents” who are not eligible to be claimed for the CTC.

Got it? The IRS has several  publications, webpages, tools, and checklists to help taxpayers navigate this. We do know that when taxpayers erroneously claim the EITC regarding children who are not their qualifying children, the most common error is that the residency requirement is not met. (See the discussion in the National Taxpayer Advocate’s 2018 Annual Report to Congress for more detail.) The IRS has a list of documents that taxpayers can submit to prove residency if they are audited.  Taxpayers should familiarize themselves with the necessary support for residency.

What happens if the IRS audits a taxpayer’s 2020 return and asserts a ban?

If a taxpayer claims the EITC, CTC, AOTC or ODC on a 2020 return, one or more of these credits is disallowed in an audit, and the IRS proposes a ban, the IRM requires the IRS to:

• Explain why it is asserting a ban on Form 886-A, Explanation of Items, which is a schedule or exhibit to the audit report it sends the taxpayer;
• Speak to the taxpayer before imposing the ban, if this is the first time the IRS is auditing the taxpayer regarding the disallowed credit, and the taxpayer has responded to the audit; and
• Record managerial approval of the ban on its Correspondence Examination Automation Support (CEAS) database.

Taxpayers have four options:

1. Agree: A taxpayer may agree to the proposed additional assessment and ban.
2. Disagree: If a taxpayer does not agree and does not seek a conference with the IRS Independent Office of Appeals (or does not prevail in an Appeals conference), the IRS will issue a statutory notice of deficiency.
3. Tax Court: Upon receipt of a statutory notice of deficiency, a taxpayer may seek review of the IRS’s determination to impose additional tax in the United States Tax Court. However, it’s not clear whether the Tax Court has jurisdiction to consider whether the ban was properly imposed. I recommended that Congress clarify the Tax Court’s jurisdiction in ban cases in the 2020 and 2021 National Taxpayer Advocate Annual Report to Congress Purple Books.
4. Audit Reconsideration: Once the ban has been imposed, the IRS sends Notice CP 79A, We Denied One or More of the Credits Claimed on Your Tax Return and Applied a Two-Year Ban, reciting that it denied one or more credits claimed on the return and applied a two-year ban. A taxpayer can then ask the IRS for audit reconsideration of the audit findings. (See IRM 4.13.3.17, Audit Reconsiderations EITC 2/10 Year Ban, for those procedures.) In a typical audit reconsideration, the taxpayer believes that the audit resulted in an inappropriate increase in tax liability and requests the IRS to reevaluate the audit findings. Audit reconsideration is an informal process and a highly effective tool for taxpayers and should be considered as an option to resolve the issue. There is no specific time limit for requesting audit reconsideration, but there are deadlines for requesting refunds.

What if the IRS audited a previous return and imposed a ban still in effect for tax year 2020?

If the IRS audited a return a taxpayer filed for a tax year prior to 2020 and imposed a ban, and the taxpayer claims the banned credit on a 2020 return, the IRS will use its math error authority to summarily assess additional tax (which includes reducing the refund due) that arises from disallowing the credit. If a taxpayer responds to the math error notice within 60 days by requesting abatement of the tax, the IRS will reverse the summary adjustment and issue a notice of deficiency. This notice of deficiency, like the notice of deficiency the IRS issued when it imposed the ban, may also assert an accuracy-related penalty due to “negligence or disregard of rules or regulations.” A taxpayer then has the option of petitioning the Tax Court for a redetermination of the tax for that year, but the Tax Court’s jurisdiction to decide whether the ban should have been imposed is unclear. If the taxpayer requests audit reconsideration of the 2020 assessment, the IRS will consider whether the ban was properly imposed in 2019.

Does the IRS always follow its own procedures when imposing bans?

In a 2019 Annual Report to Congress Research Study, we described characteristics of two-year EITC bans imposed on taxpayers as a result of an audit of their 2016 tax return (3,831 taxpayers were subjected to these bans). One finding was that in 19 percent of the cases, the taxpayer did not participate in the audit, or mail sent to the taxpayer was returned as undeliverable. Because imposing the ban requires the IRS to first ascertain the taxpayer’s state of mind, it seems unlikely, where there was no contact with the taxpayer, that the IRS can accurately determine the erroneous claim is due to “reckless or intentional disregard of rules and regulations.” We then considered a representative sample of the 3,831 taxpayers (meaning that our findings can be projected to the population) and found that:

• 54 percent of the time, the bans lacked the required managerial approval;
• 84 percent of the time, the attached Form 886-A did not explain why the ban was imposed; and
• 61 percent of the time, the IRS did not speak to taxpayers in the sample being audited for the first time before imposing a ban, as required by the IRM.

We also found that taxpayers rarely sought audit reconsideration. For almost a third of the taxpayers who did seek reconsideration, however, their persistence resulted in allowance of the banned credits in full or in part. Still, the IRS almost never removed the ban from the taxpayer account, even when the banned credit was allowed in full. So even though taxpayers potentially get relief using this avenue, they should follow up to ensure that if the claimed credit is allowed the ban is removed.

Recommendations

I urge the IRS to ensure that two-year bans are imposed only when the statutory requirements have been met, i.e., after determining that the taxpayer claimed the credit due to reckless or intentional disregard of rules and regulations. I also urge the IRS to ensure that the bans are imposed consistently in accordance with IRM procedures, such as securing managerial approval before imposing a ban and adequately explaining why the ban is being imposed. IRM procedures should require the IRS to speak with the taxpayer in every case before imposing a ban and the IRS should ensure this requirement is followed (unlike the current practice of not speaking to the taxpayer even in first-time audits, even though the IRM requires it). In addition, I recommend the IRS continue reaching out to communities with high refundable credit audit rates to ensure that taxpayers and tax practitioners are aware of the manifold rules associated with these credits claiming the total credits taxpayers are eligible to receive.