Research and Related Studies

This study expands upon two studies, described in the National Taxpayer Advocate’s 2016 and 2017 Annual Reports to Congress, of taxpayers who received educational letters from the National Taxpayer Advocate in January 2016 or January 2017. The National Taxpayer Advocate sent the letters to taxpayers who appeared to have claimed the Earned Income Tax Credit (EITC) in error because they did not meet the relationship or residency requirements, or another taxpayer claimed EITC with respect to the same child. The letters explained the requirements for claiming EITC with respect to a qualifying child and advised which requirement the taxpayer did not appear to meet.

This study considers the effect of the TAS letters on taxpayers’ compliance in claiming EITC in the years following the year in which they received TAS’s letter.

The Internal Revenue Code (IRC) authorizes the IRS to ban taxpayers from claiming certain refundable credits (the Earned Income Tax Credit (EITC), the Child Tax Credit (CTC), or the American Opportunity Tax Credit (AOTC)) for two years if it determines that the taxpayer claimed the credit recklessly or with intentional disregard of rules and regulations. A review of a representative sample of cases in which the bans were imposed as a result of audits of tax year 2016 returns shows the IRS often did not follow its own procedures. These improper bans deprived taxpayers, if they were otherwise eligible for a credit in the ensuing two years, of significant tax benefits.

Tax administrations rely on audits as a key tool for promoting and enforcing tax compliance. Since audit resources are costly and scarce, however, they are largely reserved for cases with substantive compliance risks. The overall audit rate for U.S. federal individual income tax returns has decreased over time, from one percent of returns filed in 1990 to six-tenths of one percent of returns filed in 2017. There also has been a substantial change in the composition of audits over this period. Whereas face-to-face audits accounted for the majority (62 percent) of all examinations of returns filed in 1990, the lion’s share (81 percent) of all audits of returns filed in 2017 were conducted through correspondence. More generally, the findings point to a need for further investigation into the proper balance between face-to-face and correspondence examinations. While face-to-face audits increased reported tax in the next two tax years after the audit, a group of correspondence audits actually resulted in decreased tax reporting in the two years after the audit.  The findings point to a need for further investigation into the proper balance between face-to-face and correspondence examinations.

Organizations recognized by the IRS as exempt under Internal Revenue Code (IRC) § 501(c)(3) may be exempt from federal tax, and contributions to them may be tax deductible. For decades, Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, was the IRS form organizations used to request recognition of IRC § 501(c)(3) status. Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, was introduced in 2014. It is a truncated version of Form 1023, consisting mainly of checkboxes, and requires applicants to attest, rather than demonstrate, that they meet the requirements for IRC § 501(c)(3) status. Form 1023-EZ was revised in 2018 to require applicants to provide a description (in 255 characters or less) of their mission or most significant activities. However, according to IRS procedures, the described mission or activities need only be “within the scope of IRC § 501(c)(3)” to be deemed sufficient. According to the 2019 study results, the IRS made erroneous determinations more frequently after it added the description field.