    Earned Income Credit: Qualifying Child Certification Test Appears
    Justified, but Evaluation Plan Is Incomplete (30-SEP-03,
    GAO-03-794).

    The Earned Income Credit (EIC), a tax credit available to the
    working poor, has experienced high rates of noncompliance. Unlike
    many benefit programs, EIC recipients generally receive payments
    without advance, formal determinations of eligibility; the
    Internal Revenue Service (IRS) checks some taxpayers' eligibility
    later. IRS estimated that tax year 1999 EIC overclaim rates, the
    most recent data available, to be between 27 and 32 percent of
    dollars claimed or between $8.5 billion and $9.9 billion. To
    address overclaims, IRS plans to test a new certification
    program. Because IRS's plans have garnered much attention,
    Congress asked us to (1) describe the design and basis for the
    EIC qualifying child certification program, (2) describe the
    current status of the program, including significant changes, and
    (3) assess whether the program is adequately developed to prevent
    unreasonable burden on EIC taxpayers and improve compliance so
    that the test should proceed.
    -------------------------Indexing Terms-------------------------
    REPORTNUM:   GAO-03-794
        ACCNO:   A08609
      TITLE:     Earned Income Credit: Qualifying Child Certification Test
    Appears Justified, but Evaluation Plan Is Incomplete
         DATE:   09/30/2003
      SUBJECT:   Federal taxes
    	     Noncompliance
    	     Strategic planning
    	     Tax administration
    	     Tax administration systems
    	     Tax credit
    	     Tax violations
    	     Taxpayers
    	     Eligibility determinations
    	     Program evaluation
    	     IRS Earned Income Credit Program

    ******************************************************************
    ** This file contains an ASCII representation of the text of a  **
    ** GAO Product.                                                 **
    **                                                              **
    ** No attempt has been made to display graphic images, although **
    ** figure captions are reproduced.  Tables are included, but    **
    ** may not resemble those in the printed version.               **
    **                                                              **
    ** Please see the PDF (Portable Document Format) file, when     **
    ** available, for a complete electronic file of the printed     **
    ** document's contents.                                         **
    **                                                              **
    ******************************************************************
    GAO-03-794

    United States General Accounting Office

    GAO

                           Report to Congressional Requesters

    September 2003

    EARNED INCOME CREDIT

     Qualifying Child Certification Test Appears Justified, but Evaluation Plan Is
                                       Incomplete

                                           a

    GAO-03-794

    Highlights of GAO-03-794, a report to congressional requesters

    The Earned Income Credit (EIC), a tax credit available to the working
    poor, has experienced high rates of noncompliance. Unlike many benefit
    programs, EIC recipients generally receive payments without advance,
    formal determinations of eligibility; the Internal Revenue Service (IRS)
    checks some taxpayers' eligibility later. IRS estimated that tax year 1999
    EIC overclaim rates, the most recent data available, to be between 27 and
    32 percent of dollars claimed or between $8.5 billion and $9.9 billion. To
    address overclaims, IRS plans to test a new certification program.

    Because IRS's plans have garnered much attention, you asked us to (1)
    describe the design and basis for the EIC qualifying child certification
    program, (2) describe the current status of the program, including
    significant changes, and (3) assess whether the program is adequately
    developed to prevent unreasonable burden on EIC taxpayers and improve
    compliance so that the test should proceed.

    September 2003

    EARNED INCOME CREDIT

    Qualifying Child Certification Test Appears Justified, but Evaluation Plan Is
    Incomplete

    The Assistant Treasury Secretary and IRS Commissioner convened a task
    force to identify ways of reducing EIC overclaims while minimizing
    taxpayer burden and maintaining the EIC's relatively high participation
    rate. In August 2002, the Secretary approved a recommendation to certify
    taxpayers' eligibility to claim EIC qualifying children. The proposal is
    based on analyses of the leading sources of EIC errors, thus focusing
    attention and burden on the subset of taxpayers most likely to make those
    errors.

    Since August 2002, IRS has made key changes to the certification program,
    including concentrating on residency certification and postponing
    relationship certification, delaying program implementation until later
    this year, and reducing the test sample from 45,000 to 25,000. Despite the
    changes, the process for selecting taxpayers, what taxpayers will receive
    from IRS, what taxpayers are required to provide, and the program's goals
    remain fundamentally the same as originally planned. In addition, IRS has
    emphasized that program expansions, if any, will depend on the results of
    this year's test. The process would involve three key stages as shown
    below.

    The EIC Certification Process as Envisioned

    GAO recommends that the Commissioner of Internal Revenue accelerate the
    development of IRS's plan to evaluate the certification test. The plan
    should demonstrate how the program's objectives would be evaluated,
    including milestones for conducting the evaluation. The Commissioner said
    that IRS would further develop its evaluation plan as we recommended.

    www.gao.gov/cgi-bin/getrpt?GAO-03-794.

    To view the full report, including the scope and methodology, click on the
    link above. For more information, contact Michael Brostek at (202)
    512-9110 or brostekm@gao.gov.

    These changes, including the most recent, help achieve a better balance
    between preventing unreasonable taxpayer burden and addressing the EIC's
    high overclaim rate and support IRS's plans to test the certification
    program. However, IRS's plan for evaluating the test is incomplete,
    presenting only some information on how IRS would evaluate whether
    certification would reduce the EIC overclaim rate, minimize burden, and
    maintain a relatively high participation rate. The plan proposes potential
    options for identifying how and when certain critical data will be
    obtained, but does not provide further details on when decisions will be
    made or on the specific data that will be collected. Officials have
    developed preliminary drafts identifying data to be obtained and have
    begun considering how to use contractors to gather the data. Because the
    data relate to taxpayers' actions that will occur next spring, IRS appears
    to have some time to finalize its evaluation plan.

    Contents

      Letter

    Results in Brief

    Background

    Task Force Considered Much Information Related to EIC Compliance before
    Recommending Qualifying Child Certification Program

    IRS Has Made Key Changes to Its Initial Qualifying Child Certification
    Program and More May Occur

    Qualifying Child Certification Program Developed to Improve Compliance
    While Considering Taxpayers' Burden, but Plan for Evaluating Test Is
    Incomplete

    Conclusions

    Recommendations for Executive Action

    Agency Comments and Our Evaluation 1 2 5

    9

    18

    31 38 39 40

    Appendixes

    Appendix I:

    Appendix II:

    Appendix III:

    Appendix IV:

                                           Appendix V: Appendix VI: Appendix VII:

    Significant Noncompliance Rates Other Than for the EIC

    Overclaim Rates, Administrative Costs, and Eligibility Verification
    Processes of Benefit Programs

    Objectives, Scope, and Methodology

    Objectives
    Scope and Methodology

    Key Milestones for the Qualifying Child Certification Program

    Documents Related to the Precertification Program

    Comments from the Internal Revenue Service

    GAO Contacts and Staff Acknowledgments

    GAO Contacts Acknowledgments 41

    44

    50 50 51

    54

    55

    65

    71 71 71

    Tables           Table 1: EIC Requirements for Tax Year 2002             6
                       Table 2: EIC Overclaim Rates for 1997 and 1999          10
                             Table 3: Recent Statutory Changes                 12
               Table 4: Overclaim Rates, Administrative Costs, and Eligibility
                             Verification Processes for EIC and Other Programs 45
              Table 5: How Overclaim Rates Are Calculated for Selected Benefit
                                          Programs                             49

    Contents

                          Table 6: Questions We Were Asked 50

    Figures Figure 1: Estimated Percentage of EIC Taxpayers (with Children)
                         Who Made Residency Errors and Filed Single or Head of
                                      Household in Tax Year 1999               17
               Figure 2: IRS's Process to Identify the Population of Taxpayers
                          from Which the 25,000 Person Test Sample Was Drawn   22
               Figure 3:      The EIC Certification Process as Envisioned      24
               Figure 4:     Key Milestones for the Certification Program      54

    Abbreviations

    EIC Earned Income Credit
    IRS Internal Revenue Service
    AGI Adjusted Gross Income
    FCR Federal Case Registry
    SB/SE Small Business/Self Employed
    NRP National Research Program
    TCMP Taxpayer Compliance Measurement Program

    This is a work of the U.S. government and is not subject to copyright
    protection in the United States. It may be reproduced and distributed in
    its entirety without further permission from GAO. However, because this
    work may contain copyrighted images or other material, permission from the
    copyright holder may be necessary if you wish to reproduce this material
    separately.

    A

    United States General Accounting Office Washington, D.C. 20548

    September 30, 2003

    The Honorable Amo Houghton
    Chairman, Subcommittee on Oversight
    Committee on Ways and Means
    House of Representatives

    The Honorable Earl Pomeroy
    Ranking Minority Member, Subcommittee on Oversight
    Committee on Ways and Means
    House of Representatives

    The Earned Income Credit (EIC), a tax credit available to the working
    poor,
    has generally been considered a successful antipoverty program by
    researchers. In recent years, the Internal Revenue Service (IRS) has paid
    about $30 billion annually to about 20 million EIC recipients. However,
    the
    EIC program has long experienced high rates of noncompliance. For tax
    year 1999, IRS estimated the EIC overclaim rates1 ranged between 27 and
    32 percent of dollars claimed or between $8.5 billion and $9.9 billion.
    Unlike many benefit programs, EIC recipients generally receive payments
    without a prior, complete review of their eligibility; IRS checks some
    aspects of taxpayers' eligibility before and after the credit is granted.

    To help combat the high rates of noncompliance, IRS plans to test a new
    program, beginning in December 2003.2 Referred to as the qualifying child
    certification program, some taxpayers will be asked to verify EIC
    "residency" requirements3 for their qualifying children before getting
    that
    portion of their refund or reduction in tax liability. IRS plans to test
    the EIC
    program with 25,000 taxpayers whose residency cannot be confirmed

    1Overclaim rates are calculated based on erroneous claim amounts less any
    amounts IRS recovered or expects to recover, such as through examinations.
    IRS also has limited information on underclaim rates, or instances in
    which taxpayers claimed less than they were entitled to receive. This
    report primarily focuses on IRS's efforts to address noncompliance related
    to overclaims using the qualifying child certification program.

    2The program discussed in this report is one part of a strategy to target
    three major known sources of EIC noncompliance. The other two parts
    involve the improper reporting of filing status, such as among married
    taxpayers who report as single or head of household to avoid reporting
    their spouse's income, and income misreporting, such as underreporting
    earned income.

    3Taxpayers must meet multiple criteria in order to claim the EIC, as shown
    in table 1. Residence is one criterion for a taxpayer with a qualifying
    child.

    through other means. Future plans for the program largely depend upon the
    results of this test.

    Because IRS's plans surrounding the program have garnered much attention,
    you asked us to respond to questions about the qualifying child
    certification program. These questions cover various topics, such as the
    status of the program, understandability of letters and forms going to
    taxpayers, certification requirements and taxpayers' ability to comply,
    taxpayer burden, impact on compliance rates, impact of recent legislative
    changes, and data from other federal or state benefit programs. We grouped
    these questions into three objectives: (1) describe the design and basis
    for the EIC qualifying child certification program as proposed by the EIC
    task force, (2) describe the current status of the program, including
    significant changes since program approval, and (3) assess whether the
    program is adequately developed to (a) prevent unreasonable burdens on EIC
    taxpayers and (b) improve compliance so that the test should proceed. In
    addition, you asked us to provide readily available information on the (1)
    significant noncompliance rates other than for the EIC and (2) overclaim
    rates and administrative costs of comparable benefit programs administered
    by states or the federal government and any verification process used by
    these programs. This information is presented in appendixes I and II,
    respectively.

    This report is based primarily on our previous work and analysis of IRS
    and Department of the Treasury documents and reports, new letters and
    forms that will be sent to taxpayers, and interviews with senior officials
    at IRS and Treasury. We did not verify the accuracy of reports or data
    obtained. Rather, we reviewed the steps IRS officials had taken to
    implement the program and determined, to the extent possible, how they
    assured themselves that the program had been adequately developed to
    prevent unreasonable burden and improve compliance. We did not determine
    the adequacy of various other preparations for the qualifying child test,
    such as staffing and training of staff. Appendix III provides more detail
    on the scope and methodology used in conducting our work.

    Results in Brief	Due to persistently high EIC noncompliance, among other
    factors, the Assistant Secretary of the Treasury and IRS Commissioner
    convened a task force in February 2002 to find ways of reducing EIC
    overclaim rates while minimizing the burden to taxpayers and maintaining
    the EIC's relatively high participation rate. The task force considered
    the likely effect of recent legislative changes on EIC compliance in
    formulating its proposal to

    combat noncompliance. It also considered various options, such as
    partnering with other federal or state agencies to verify EIC taxpayers'
    eligibility. The task force analyzed data and reviewed studies to design
    the program to focus on known sources of noncompliance. In August 2002,
    the Treasury Secretary approved the task force recommendation that IRS
    certify the eligibility of taxpayers' qualifying children. Only taxpayers
    most likely to make errors and whose qualifying child eligibility cannot
    be verified from available information would be asked to certify.

    Since taking its broad charge from the task force, IRS obtained input from
    external and internal stakeholders, and made key changes to the
    certification program, including (1) concentrating on residency
    certification and postponing the relationship certification for an
    undetermined period of time, (2) delaying program implementation until
    later this year, and (3) reducing the test sample from 45,000 to 25,000.
    According to IRS officials, the relationship portion of the program was
    postponed indefinitely for several reasons, including concerns raised
    about the proposed relationship certification form and studies that have
    shown meeting requirements for relationship is less of a compliance issue
    than meeting residency requirements. IRS had previously changed the start
    date of the test, and, as we were finalizing this report, announced in
    August 2003, that it was again delaying the program and now plans to send
    letters about the qualifying child certification program to taxpayers in
    December 2003. With this change, taxpayers will now have to provide proof
    that qualifying children meet the residency test when they file their 2003
    individual income tax returns; thus, any unresolved issues could result in
    frozen refunds. As part of the August announcement, IRS also reduced the
    number of taxpayers that will be included in the test from 45,000 to
    25,000, in part, in response to comments received during a 30-day public
    period. However, these changes create additional challenges for IRS and
    taxpayers. For example, the test will no longer be a direct test of the
    original concept of certifying taxpayer eligibility in advance of the
    filing season. At the same time, the process for selecting taxpayers, what
    taxpayers will receive from IRS, and what taxpayers will be asked to
    provide to prove the residency of a qualifying child remains basically the
    same as originally planned. Further, IRS officials have emphasized that
    program expansions, if any, will depend on the results of the test.

    The changes made in the proposed certification program-including the ones
    announced in August-help achieve a better balance between preventing
    unreasonable taxpayer burden and addressing the EIC's high overclaim rate,
    and support IRS's plans to move forward with the residency

    test. The qualifying child program is based on analyses of the leading
    sources of EIC errors, thus focusing attention and burden on the subset of
    taxpayers making those errors as opposed to all EIC recipients. In
    addition, IRS has taken steps to address the burden taxpayers will
    experience as participants in the test this year. However, IRS's plan for
    evaluating the results of the test is not yet complete. Although an
    evaluation plan does not have to completely identify all issues or how
    they will be evaluated prior to a program's start, the more completely a
    plan is developed, the more likely that the evaluation will be sufficient
    to support future decisions. The draft evaluation plan presents only some
    information on how IRS will show whether certification's objectives-reduce
    the overclaim rate, minimize burden, and maintain the EIC's relatively
    high participation rate-will be achieved. However, the plan proposes
    potential options for identifying how and when some critical data will be
    obtained and analyzed, but does not provide further details on when, how,
    and by whom decisions will be made on the specific data that will be
    collected. Officials have developed preliminary drafts identifying data to
    be obtained and have begun considering how to use contractors to gather
    the data. Since the data relates to taxpayers' actions that will occur
    next spring, IRS has some time to finalize the evaluation plan.

    We are recommending that the Commissioner of Internal Revenue, to the
    extent possible, accelerate the development of the evaluation plan, and
    have the plan demonstrate how each program objective will be evaluated,
    including milestones for critical steps such as how data will be obtained
    and analyzed in time to support decisions about the future of IRS's
    certification program.

    We requested comments on a draft of this report from the Commissioner of
    Internal Revenue. We received written comments, which are reprinted in
    appendix VI. In his comments, the Commissioner said that IRS would be
    including the components we suggested in their evaluation plan and said
    that IRS is working to incorporate these components well before the
    certification test begins. We further discuss the Commissioner's comments
    in the "Agency Comments and Our Evaluation" section of the report.

    Background	Congress enacted the EIC in 19754 with the goal of offsetting
    the Social Security taxes paid by the working poor and creating a greater
    work incentive for low-income taxpayers. According to data cited in the
    task force report, an estimated 4.3 million individuals were lifted out of
    poverty in 1998 by the EIC, including 2.3 million children.

    The EIC is a refundable tax credit, meaning that qualifying working
    taxpayers may receive a refund greater than the amount of income tax paid
    during the year. Taxpayers can qualify for the credit in one of two ways:
    with a "qualifying child" or by "income only," if they do not have a
    qualifying child. For example, for tax year 2002, the amount of EIC that
    could be claimed with a qualifying child or children ranged from $0 to
    $4,140. EIC payments have a phase-in range in which higher incomes yield
    higher EIC amounts, a plateau phase in which EIC amounts remain the same
    even as income rises, and a phase-out range in which higher incomes yield
    lower EIC payments or tax liability.

    EIC requirements for tax year 2002 include rules for everyone, additional
    rules for taxpayers with qualifying children, and additional rules for
    taxpayers without qualifying children, as shown in table 1.

    426 U.S.C. Sec. 32.

                      Table 1: EIC Requirements for Tax Year 2002

    Additional rules for Additional rules for Rules for all taxpayers
    taxpayers with a qualifying taxpayers without a claiming the EIC child
    qualifying child

    Must have a valid Social Income limitations: If one Income limitations:
    $11,060

    Security number	child: $29,201 (or $30,201 if (or $12,060 if married
    filing married filing jointly). If more jointly). than one child: $33,178
    (or $34,178 if married filing jointly).

    Cannot use married filing Child must meet age, Must be at least 25 years
    separately status relationship, and residency old, but under 65

    tests

    Must be a U.S. citizen or Child can be claimed by one Taxpayer cannot be
    the

    resident alien all year taxpayer only 	dependent of another person

    Cannot file form 2555 or Taxpayer cannot be a Taxpayer cannot be a

    2555-EZ	qualifying child of another qualifying child of another taxpayer
    taxpayer

    Investment income must be Must have lived in U.S. more $2,550 or less than
    half of a year

                                Must have earned income

    Source: IRS.

    IRS has periodically measured EIC compliance for overclaims and
    underclaims. The most current data available, for tax year 1999, show EIC
    overclaim rates estimated to be between 27 and 32 percent of dollars
    claimed or between $8.5 billion and $9.9 billion. IRS has limited data on
    underclaims, which for tax year 1999 were estimated to be between $710
    million and $765 million.5 IRS has tried to reduce noncompliance through
    various means, including education and outreach to taxpayers and tax
    return preparers. In addition, Congress has enacted legislation aimed at
    resolving some concerns with EIC rules. Because a new analysis of EIC
    compliance using 2001 tax return information is not expected to be
    complete until late in 2004, IRS does not know whether compliance has
    significantly changed since 1999, but officials do not think it has
    improved

    5Underclaims refers to the amount in which taxpayers claimed less than
    what they were entitled to receive.

    substantially. Because of the persistently high rates of noncompliance, we
    have identified the EIC program as a high-risk area for IRS since 1995.6

    Currently, taxpayers claim the EIC by filing an individual income tax
    return (e.g., a Form 1040 or 1040A) and including a Schedule EIC-a
    procedure similar for claiming other tax credits. Unlike with other
    benefit programs such as Supplemental Security Income, however, EIC
    taxpayers are not required to be found qualified before claiming the
    credit or file any other documents with their return to establish
    eligibility. Instead, IRS uses four primary means to evaluate EIC
    eligibility and check for noncompliance after the return is filed and
    checks some aspects of taxpayers' eligibility before and after the credit
    is granted: (1) the math error program, (2) correspondence and
    face-to-face examinations (also called audits), (3) the document matching
    program, and (4) criminal investigations. Some of these means, such as the
    math error program, check all EIC returns, but only for limited aspects of
    eligibility. Other means, such as examinations, only check a small subset
    of EIC returns, but the review is more expansive. In general, IRS subjects
    all returns to its math error program and takes corrective action on
    errors found. Depending on the resources IRS has available, IRS works only
    a small portion of cases identified as potentially meriting follow-up
    under its examination, document matching, and criminal investigations
    efforts.

    While processing all tax returns, IRS uses its automated math error
    program to identify and correct the simpler errors found in claiming the
    EIC. For example, the math error program can identify invalid Social
    Security numbers and taxpayers who fail to follow recertification
    requirements.7 As a result, some inappropriate EIC claims are stopped
    before refunds are issued. During fiscal year 2001, IRS stopped more than
    371,000 incorrect EIC claims using its math error authority. After
    identifying errors, IRS corrects them so the tax return can be processed
    and sends a computerized notice to the taxpayer identifying the error and
    stating that IRS disallowed or reduced the EIC claim. The notice tells

    6Prior to 2001, EIC was part of a broader IRS tax filing fraud high-risk
    area. Beginning in 2001, the focus of that designation was narrowed to EIC
    specifically. U.S. General Accounting Office, High-Risk Series: An Update,
    GAO-01-263 (Washington, D.C.: January 2001).

    7Taxpayers are required to meet recertification requirements when they
    have been denied the EIC in a previous year. Recertification involves
    taxpayers providing documentation, such as a birth certificate, to support
    their claim of a relationship to a qualifying child.

    taxpayers that if they can correct the error, the EIC claim will be
    allowed and any refund related to the EIC claim will be issued.

    Two types of examinations--correspondence and face-to-face-are used when
    EIC noncompliance is suspected, in most cases before refunds are issued.
    IRS uses various systematic means to "score" the likelihood of
    noncompliance on any return and uses experienced staff to manually
    identify the specific items on returns for examination. Most EIC
    examinations occur shortly after a return is filed, largely because of the
    difficulty in recovering refunds. IRS stops refunds on these returns until
    examinations are completed. This contrasts with IRS's normal examination
    practice of performing examinations many months after tax returns have
    been processed and any refunds paid. The EIC examinations usually rely on
    correspondence with taxpayers rather than face-to-face contacts. IRS
    completed about 368,000 EIC related correspondence exams during fiscal
    year 2002. IRS tends to use face-to-face meetings with taxpayers to
    examine tax returns with EIC claims on a very limited basis and primarily
    when examinations are initiated for other reasons. As part of either type
    of examination, however, IRS would describe the potential noncompliance in
    a computerized notice to taxpayers claiming the EIC. IRS requests
    documentation, such as a school record or birth certificate, to establish
    EIC requirements. Depending on whether IRS officials accept or reject the
    support, they may make changes to the return and refund related to the EIC
    claim. If taxpayers disagree with IRS's decisions, they have the right to
    appeal administratively and/or through the courts.

    IRS also uses its document matching programs to identify potentially
    misreported income on tax returns claiming the EIC. By comparing the tax
    return to wage and income statements provided by third parties such as
    employers and financial institutions, the document-matching program
    identifies whether a taxpayer appears to have misreported income. Given
    the phase-in and phase-out ranges of the EIC, some taxpayers may claim too
    much EIC by overreporting or underreporting their income. This program
    notifies such taxpayers months after returns are filed and refunds are
    issued. Similar to audits, a notice is issued telling a taxpayer that an
    error appears to have been made, that he or she may disagree and provide
    any support for income reported, and that he or she may appeal IRS's
    decision about additional taxes owed. Unlike audits, the program is highly
    automated and is designed to require less contact with taxpayers by IRS
    staff.

    IRS also uses criminal investigations to stop the payment of false
    refunds, identify refund scams/schemes, and prosecute perpetrators,
    including those with fraudulent EIC claims. For EIC, IRS uses a specific
    computer program that looks for questionable refund claims and for return
    preparers known to have prepared questionable returns. IRS also has teams
    that scan returns and receive referrals from other parts of IRS and
    informants. IRS stops many returns as they are being processed so that
    criminal investigators can review the claims before the refund is paid or
    after the return has been processed.

    Task Force Considered Much Information Related to EIC Compliance before
    Recommending Qualifying Child Certification Program

    When IRS's study of EIC compliance rates for 1999 was released, the
    Assistant Secretary of the Treasury and IRS Commissioner convened a task
    force in February 2002 to find ways of reducing EIC overclaims while
    minimizing the burden to taxpayers and maintaining the EIC's relatively
    high participation rate. The task force considered whether changes in
    statutes recently enacted by Congress or proposed by Treasury may have
    lessened the need for new EIC compliance initiatives and concluded that,
    while statutory changes addressed some sources of noncompliance, they
    likely would not reduce other leading sources of noncompliance. The task
    force also considered a range of new methods, including partnering with
    other federal or state agencies or programs and developing a new database
    to verify EIC eligibility before issuing tax refunds, but decided that
    these options were not viable. Ultimately, the task force recommended the
    qualifying child certification program. The task force reviewed IRS's EIC
    compliance study results and other data, as well as other studies, to
    identify the sources and develop new methods of addressing noncompliance.

    Task Force Convened to Address Long-Standing Compliance Problem

    The joint Treasury and IRS task force addressed a long-standing problem of
    high EIC overclaim rates. Although the release of IRS's 1999 compliance
    study precipitated the formation of the EIC task force in February 2002,
    the study results were generally consistent with high overclaim rates
    reported in prior IRS studies. While some stakeholders view the 1999 study
    as having some methodological weaknesses, it showed that of the
    approximately 20 million taxpayers that claimed the EIC in 1999, 46 to 50
    percent of their tax returns had errors that led to claiming too much of
    the credit (IRS often refers to this as the error rate). IRS also
    estimated that the total dollars overclaimed on those returns represented
    between 27 and 32 percent of total EIC dollars claimed in 1999, or between
    $8.5 billion and $9.9 billion.

    IRS also has some data on underclaims-instances where taxpayers claimed
    less than they were entitled to receive. For tax year 1999, underclaims
    were estimated to be between $710 million and $765 million.

    IRS has conducted EIC compliance studies for several years and the
    overclaim rate, which is the percentage of total dollars paid out in
    error, was estimated to be about 24 percent in tax year 1994. According to
    IRS officials, because different methodologies were used in the subsequent
    studies, changes in estimated overclaims found in other studies do not
    support conclusions about trends in the overclaim rate over time. However,
    IRS officials also acknowledged the overclaim rate has not improved
    significantly. Overclaim rates for tax years 1997 and 1999 are shown in
    table

    2. The information in table 2 does not reflect the current compliance
    situation; for example, it does not reflect the presumably positive impact
    of new legislation that has taken effect since 1999 aimed at improving
    compliance.

        Table 2: EIC Overclaim Rates for 1997 and 1999 Tax year Lower-bound rate
                                    Upper-bound rate

                                    1997 23.8% 25.6%

                                    1999 27.0% 31.7%

    Source: IRS data.

    Note: Because not all individuals responded to audit contacts, IRS uses
    certain assumptions to estimate the overclaim rate range. The lower-bound
    rate assumes that the overclaim rate for the nonrespondents is the same as
    for the respondents, while the upper-bound assumes that all nonrespondents
    are overclaims.

    Although IRS's studies have shown high EIC overclaim rates for many years,
    other studies had shown that EIC's participation rate was fairly high. For
    example, in 2001 we reported that an estimated three of every four
    eligible participants received the EIC in tax year 1999.8 For taxpayers
    with one or two qualifying children, we estimated that participation rates
    exceeded 90 percent. Individuals with no children, who receive a much
    smaller credit than taxpayers with qualifying children, had a much lower
    participation rate that we estimated to be about 45 percent. Although at
    the time we reported that available data did not enable us to determine
    the

    8U.S. General Accounting Office, Earned Income Tax Credit Participation,
    GAO-02-290R (Washington, D.C.: Dec. 14, 2001).

    reasons for these differences, IRS officials attributed these differences,
    in part, to the lower EIC amounts allowed for individuals and because the
    program did not include individuals without children when it first began.

    Task Force Reviewed Recent Legislative Changes Likely to Improve
    Compliance

    The EIC task force reviewed whether recent statutory changes have the
    potential to reduce the major sources of EIC noncompliance, either by
    changing the rules or providing IRS new enforcement options. Because the
    study of tax year 1999 compliance was the most recent available, the task
    force lacked data on the effect of the recent changes and relied on other
    analyses that showed whether the changes would affect compliance. Of the
    recent changes, the task force estimated that one change, to the Adjusted

    Gross Income (AGI) tiebreaker rule,9 would likely reduce noncompliance.
    The task force judged that the other legislative changes, including those
    proposed by Treasury, while potentially helping reduce noncompliance from
    other sources, would not be enough to reduce noncompliance without further
    IRS efforts.

    Three key pieces of legislation, which have been recently enacted or taken
    effect, were at least partially aimed at improving EIC compliance, as
    shown in table 3. They may eventually help reduce noncompliance after
    taxpayers and tax preparers become familiar with the new laws. The
    statutory changes were to serve several purposes, including improving
    compliance and simplifying tax laws associated with the EIC.

    9The new AGI tiebreaker rule applies when two taxpayers can claim the same
    qualifying child. If one of the taxpayers claiming the credit is the
    child's parent (or parents who file a joint return), then the child is
    considered the qualifying child of the parent or parents. If both parents
    claim the child and parents do not file a joint return, then the child is
    considered a qualifying child first of the parent with whom the child
    resided for the longest period during the year, and second of the parent
    with the highest adjusted gross income. If none of the taxpayers claiming
    the child as qualifying is the child's parent, the child is considered a
    qualifying child with respect to the taxpayer with the highest adjusted
    gross income.

    Table 3: Recent Statutory Changes Law Change

    Economic Growth and Tax Relief This act made several changes, including
    (a) effective Reconciliation Act of 2001(P.L. for tax years after December
    31, 2001, simplifying the 107-16, March 7, 2001) "Adjusted Gross Income
    tiebreaker rule," (b) for tax

    years beginning after December 31, 2001, establishing a new definition for
    earned income by eliminating non-taxable earned income and by having the
    Earned Income Credit (EIC) based on adjusted gross income, (c) for tax
    years beginning after December 31, 2001, amending the definition of a
    foster child by reducing the residency requirement to over half a year,
    and (d) effective January 1, 2004, allowing the IRS to use math error
    authority to deny EIC claims if the Federal Case Registry (FCR) indicates
    that the taxpayer is the noncustodial parent of the qualifying child with
    whom the credit is claimed.

    Ticket to Work and Work Effective after December 31, 1999, part of this
    act	Incentives Improvement Act of simplified the definition of a foster
    child.	1999 (P.L. 106-170, December	17, 1999)

    Tax Relief Act of 1997 (P.L. 105-After October 1,1998, this act requires
    that each

    34, August 5, 1997)
    record in the state registry include the Social Security number of any
    child for whom support has been ordered. This information is included in
    the FCR database. It also requires an applicant for a Social Security
    number who is under age 18 to provide his or her parent's Social Security
    numbers, in addition to other required evidence, such as age, identity,
    and citizenship.

    Source: GAO analysis of legislation.

    A Treasury study showed that the change in the AGI tiebreaker rule
    effective for tax years after December 31, 2001, would likely have
    eliminated about $1.4 billion of the nearly $2 billion in tax year 1999
    EIC overclaims that were due to tiebreaker errors. Accordingly, the task
    force decided that this source of EIC overclaims did not need to be
    further addressed by a new compliance initiative.

    Although officials recognized the benefits of these recent legislative
    changes to help improve EIC compliance, they concluded that additional
    initiatives were still needed. For example, officials recognized the value
    of IRS being able to use math error authority to deny EIC claims on and
    after January 1, 2004, when the Department of Health and Human Services'
    Federal Case Registry (FCR) indicates that the taxpayer is the
    noncustodial parent of the qualifying child. However, officials told us
    that this authority

    was limited and not applicable to a significant number of taxpayers whose
    compliance may be problematic. IRS has a study in process to determine the
    effectiveness of using FCR data to deny EIC claims using its math
    authority. The study was scheduled for completion by July 30, 2003, but as
    of August 20, 2003, was not yet completed.

    Task Force Considered Three Alternatives to Improve Qualifying Child
    Compliance

    The EIC task force considered three key options to verify taxpayers'
    qualifying children: (1) partnering with other federal or state agencies
    or government programs to verify EIC taxpayers' eligibility, (2) creating
    a federal database that would automatically match and detect questionable
    or erroneous EIC claims, and (3) certifying taxpayers' eligibility for
    certain EIC criteria. Ultimately, in August 2002, the Secretary of the
    Treasury approved the qualifying child certification program, which at the
    time was to include providing proof of eligibility in advance of the
    filing season (July-December), and was referred to as "precertification."

    The first two options were expected to impose little or no documentation
    requirements on taxpayers. The task force was trying to determine for both
    options whether sufficient information was already available from others,
    or that little additional information would need to be collected by
    others, to verify a taxpayer's qualifying children. However, the task
    force found that there was little overlap between the EIC population and
    verification criteria used to administer other federal or state programs.
    In addition, although some databases existed, the task force found that
    they could not be used to effectively verify EIC eligibility, largely for
    the same reason. Consequently, the task force judged that these options
    were not likely to be useful in addressing EIC compliance problems.
    Similarly, the task force also found that if a federal database were
    created to facilitate EIC verification, IRS would have to gather the bulk
    of the information itself, thus imposing a burden on taxpayers, which
    would also be costly and time-consuming for IRS. The third option, which
    the task force selected, required taxpayers to demonstrate EIC eligibility
    for certain criteria, namely residency and relationship tests for
    qualifying children, prior to receiving the credit.

    The relative cost of the options the task force considered did not drive
    the decision to select the qualifying child program because the other two
    alternatives were not considered viable. The task force did compare IRS's
    EIC administrative costs to those of other federal benefit programs and
    found them to be much smaller. IRS has had a special appropriation for EIC
    compliance initiatives since 1998-and has received about $875 million

    total through fiscal year 2003. It requested a total of about $250 million
    in fiscal year 2004, which included $100 million for the EIC compliance
    initiatives, including the qualifying child program, and about $150
    million for the special appropriation. IRS estimated that this $250
    million10 total was about 0.8 percent of the total annual EIC benefits
    distributed, and therefore much smaller than the 9 to 13 percent
    administrative costs the task force had found for other benefit programs.
    See appendix II for more information we obtained on administrative costs
    for other benefit programs.

    Task Force Reviewed Studies and Data to Design Initiatives Focused on
    Known Sources of Compliance Problems

    The EIC task force reviewed IRS studies, other IRS data, and studies by
    other parties to better understand the sources of EIC noncompliance and
    devise new initiatives to address those known sources. In reviewing IRS
    studies and data, the task force found that the three leading sources of
    EIC errors resulting in overclaims in 1999 were (1) claiming nonqualifying
    children incorrectly, accounting for about $3 billion, (2) using the wrong
    filing status, accounting for about $2 billion, and (3) misreporting
    income, also accounting for about $2 billion. Three administrative
    proposals resulted, involving (1) qualifying child certification, (2)
    improper filing status, and (3) income misreporting.11 In 1999, another
    leading source of EIC overclaims involved taxpayers with lower modified
    adjusted gross income claiming a child when another person with a higher
    income should have done so. The task force did not propose an initiative
    dealing with these errors, primarily because the "AGI tiebreaker"
    legislation was specifically enacted to decrease this source of
    noncompliance, as previously discussed.

    10In addition to the $250 million that IRS requested in its fiscal year
    2004 budget request to administer the EIC, IRS incurs some additional
    costs. For example, IRS incurs costs to process the EIC tax returns.
    Therefore, the full cost of administering the EIC is not known.

    11Improper filing status claims and income misreporting are other common
    problems associated with the EIC. IRS plans to verify the filing status
    for about 41,650 cases in fiscal year 2004, but the criteria for selecting
    the cases have not yet been finally determined. In fiscal year 2004, IRS
    plans to use document matching to verify the income reported by about
    300,000 EIC filers who have a history of misreporting income for 2
    consecutive years in order to increase (or receive) the EIC. Depending on
    how well these efforts work in fiscal year 2004, they would be expanded in
    future years. Also see U.S. General Accounting Office, May 20 Oversight
    Hearing on the Internal Revenue Service - Questions for the Record,
    GAO-03-962R (Washington, D.C.: June 27, 2003).

    To deal with the error attributable to claiming children who are not EIC
    qualifying children, the task force proposed a qualifying child
    certification program. Based on analyses of past compliance data, IRS
    found that taxpayers who overclaimed the EIC, most frequently claimed
    children who did not meet the residency or relationship criteria.12 As a
    result, the task force proposed the qualifying child program that was to
    include an annual residency certification and a one-time relationship
    certification.

    Under this program, during the period from July through December,
    taxpayers would have been asked to document that the children they intend
    to claim under the EIC, meet the EIC relationship and residency criteria.
    The task force proposed targeting the program to those taxpayers with
    qualifying children for whom IRS could not establish residency or
    relationship through other available means and it proposed that this
    concept be tested on a sample of EIC taxpayers for the tax year 2003. The
    task force envisioned that ultimately all EIC claimants whose eligibility
    could not be verified through available means would be asked to provide
    additional eligibility documentation prior to the filing season. Taxpayers
    who successfully certified qualifying children's eligibility in advance of
    the filing season would have their claims processed and paid expeditiously
    during the filing season, absent any other problems with their tax return
    or EIC claim. Having taxpayers certify between July and December was also
    intended to allow IRS to process the taxpayers' documents outside of the
    filing season when IRS processing systems are in highest demand. Taxpayers
    who did not respond and/or were unable to document their eligibility
    during the certification period, but then claimed the EIC when they
    submitted their tax returns, would have the EIC portion of their tax
    refund frozen. Then they would be required to provide the same
    documentation during or after the filing season as they were asked to
    provide during the certification period. When and if they document their
    eligibility, the EIC portion of their refunds would be released.

    12For 2002 returns, taxpayers who claim the EIC with a qualifying child
    must meet certain tests, including residency and relationship. To meet the
    residency test, the qualifying child had to live with the taxpayer in the
    United States for more than half of the year. To meet the relationship
    test, the qualifying child had to be a son, daughter, adopted child,
    stepchild of the taxpayer, or a descendent of any such individual.
    Sisters, brothers, stepsisters, stepbrothers, and descendents of any such
    individual also qualify if the taxpayer cares for the individual as they
    would their own child. In addition, a foster child can qualify for the
    relationship test if certain conditions are met. Internal Revenue Service,
    Earned Income Credit (EIC), Publication 596 (Washington, D.C.: 2002).

    Process for Identifying Taxpayers When IRS Planned to Certify for
    Relationship

    Process for Identifying Taxpayers to Certify for Residency

    According IRS officials, as the task force neared its end and before the
    Secretary of the Treasury approved the program, IRS developed a means for
    using existing data to determine whether each taxpayer likely would meet
    the relationship or residency test for children they had claimed for EIC
    for tax year 2002. For relationship, IRS developed a plan to match
    taxpayers to several databases that show the parents of children. For
    instance, one database IRS planned to use was the Social Security
    Administration's database (which IRS refers to as KIDLINK) that ties
    parent's and children's Social Security numbers for children born after
    1998 in U.S. hospitals. For tax year 2003, IRS had planned to match 1.6
    million, or 10 percent of the approximately 16 million EIC taxpayers with
    a qualifying child, to the databases. Under this scenario, any taxpayer
    who was not shown to be the parent of a qualifying child claimed for tax
    year 2002 would then be part of the population from which IRS would
    randomly select taxpayers to test for relationship.

    IRS considered the work of the task force in developing a comparable means
    for using available data to identify those who have met the residency
    criterion. The task force had analyzed data from the 1999 compliance study
    and information in other reports.13 It found that residency errors related
    to qualifying children were often correlated with the taxpayer's
    relationship to the child and the taxpayer's filing status and gender. The
    analysis showed that, overall, parents who filed married filing jointly
    were the most compliant when compared to taxpayers filing single or head
    of household in claiming a qualifying child who meets the residency test.
    Married filing jointly parents had the fewest qualifying child residency
    errors-1.5 percent-compared to any other combination of taxpayers by
    relationship to the child, gender, or tax filing status. Among taxpayers
    who file single or head of household, mothers were the most compliant (see
    figure 1).

    13Andrew J. Cherlin and Paula Fomby, "Welfare, Children, and Families: A
    Three-City Study," A Closer Look at Changes in Children's Living
    Arrangements in Low-Income Families, Working Paper 02-01(Baltimore, MD.:
    Johns Hopkins University, Feb. 20, 2002), and Allen Dupree and Wendell
    Primus, Declining Share of Children Lived with Single Mothers in the Late
    1990s: Substantial Difference by Race and Income (Washington, D.C.: Center
    on Budget and Policy Priorities, June 15, 2001). We did not review these
    studies in detail. Instead, we relied upon IRS's assessment.

    Figure 1: Estimated Percentage of EIC Taxpayers (with Children) Who Made
    Residency Errors and Filed Single or Head of Household in Tax Year 1999

    80 Percentage

    70

    60

    50

                                          44.1

    40

    30

    20

    10

    0 mothers male fathers female nonparent nonparent

    Source: IRS data.

    Note: This figure reflects residency errors only. Mothers who filed as
    single or head of household, for example, made qualifying child residency
    errors 3.4 percent of the time, while 96.6 percent of the time, they
    either made no errors or errors other than residency-related errors.

    The task force also found other reports that reinforced the results of its
    analysis. Specifically, an independent study of low-income households in
    three urban areas estimated that children resided with biological mothers
    90 percent of the time. Another study estimated that 89 percent of
    children in low-income households lived with both parents or their mother.

    IRS used this information to propose a process for identifying taxpayers
    to include in the population that would be subject to the residency
    certification requirement. IRS proposed that the 1.6 million taxpayers, or
    10 percent of the 16 million taxpayers with a qualifying child, would be
    matched to the FCR database. IRS officials considered the FCR to be the
    most useful database for identifying those meeting the residency
    requirements. This database compiles court and other records that indicate
    who is the custodian for a child (which could be a parent or nonparent).
    IRS assumes that children live with the custodian of record. According to
    IRS, the FCR database contains custodial information for about 40 percent
    of the EIC population. If a taxpayer matched as the custodian of the child
    claimed for the EIC for 2002, the taxpayer would not

    be among those needing to certify. When the FCR database showed someone
    was the custodian of a child other than the EIC taxpayer who had claimed
    that child for the EIC in 2002, those taxpayers would be among the group
    from which the residency certification sample would be drawn.

    When the FCR contains no information about the child a taxpayer had
    claimed for EIC in 2002, the IRS would attempt to establish the
    relationship of taxpayers to qualifying children by comparing information
    in several databases. Those taxpayers IRS could identify from databases as
    the child's mother would be excluded from the sample, if they filed
    married filing jointly, single, or as head of household. Mothers would be
    excluded on the basis of the task force analyses showing mothers to be
    among the most compliant on the residency criterion. Also excluded from
    the sample would be fathers who filed as married filing jointly.
    Otherwise, all males who were shown to be a child's father filing single
    or head of household would be included in the group from which the
    certification sample would be drawn because of the data showing a high
    level of noncompliance on the residency criterion for these taxpayers.
    Finally, all nonparents who are not shown in the FCR to be the custodian
    would go into the group from which taxpayers would be selected for
    residency certification, also due to information showing nonparents to be
    among the less compliant taxpayers on the residency criterion. The
    selection processes for relationship and residency would have, therefore,
    yielded a group of taxpayers that would include some needing to certify
    for relationship only, some for residency only, and some to certify for
    both.

    IRS Has Made Key Changes to Its Initial Qualifying Child Certification
    Program and More May Occur

    Since adopting the EIC task force recommendations in August 2002, IRS has
    made key changes to the qualifying child certification program in response
    to input received and additional analyses done. Some of these changes
    include (1) postponing relationship certification for an undetermined
    period of time, (2) delaying program implementation, and (3) reducing the
    test sample from 45,000 to 25,000. However, these changes create
    additional challenges for IRS and taxpayers. Despite these challenges, the
    process for selecting taxpayers, what taxpayers will receive from IRS, and
    what taxpayers will be required to provide remains basically the same as
    originally planned. According to officials, the same factors were
    considered when setting the new sample size, which is still designed to
    allow IRS to achieve the same goals as the original sample size, albeit to
    a lesser extent.

    In addition, IRS has emphasized that program expansions, if any, will
    depend on the results of this year's test. Concerns we identified in our
    report on recertification14 were considered and taken into account by IRS
    in designing the new qualifying child certification program.

    IRS Broadly Adopted Task Force Recommendations in Its Initial Design of
    the Qualifying Child Certification Program

    IRS took the broad charge from the EIC task force and designed the
    qualifying child certification program. Its focus was to decrease the EIC
    overclaim rate while striving to maintain the high rate of participation
    and minimize taxpayer burden. Initially, IRS decided that the
    certification program would involve

    o 	testing of 45,000 taxpayers for both relationship and residency
    beginning in July 2003, and

    o 	immediately expanding the certification program for relationship to 2
    million taxpayers in 2005 and to both relationship and residency in
    substantial numbers in future years.

    However, as IRS obtained input on the program, it modified these plans.

    Certification for Residency Only Is to Begin in December 2003 for 25,000
    Taxpayers

    Since initially formulating plans for the qualifying child certification,
    IRS has made multiple changes to the program. First, IRS postponed
    relationship certification for an undetermined period for a number of
    reasons. IRS had developed a draft form for certifying relationships and
    obtained input on the form from external and internal stakeholders. Some
    stakeholders raised concerns about whether taxpayers would be able to
    provide some of the types of documentation IRS planned to request, such as
    marriage certificates, within the time envisioned. IRS officials said that
    testing the relationship certification this year was postponed, in part,
    because these concerns were unresolved. The officials also noted that
    Treasury studies have shown relationship requirements to be a lesser
    compliance issue than residency, and taxpayers that were found to be

    14 The "certification" program is different from the IRS "recertification"
    program, which is required by statute. Recertification was implemented in
    1998 and requires taxpayers who have been disallowed the EIC through an
    IRS examination to substantiate their qualification for the EIC, i.e.,
    recertify before they receive the credit again. U.S. General Accounting
    Office, Opportunities to Make Recertification Program Less Confusing and
    More Consistent, GAO-02-449 (Washington, D.C.: Apr. 25, 2002).

    noncompliant with relationship requirements were also often noncompliant
    due to residency errors. Since both residency and relationship
    requirements have to be met, if taxpayers fail certification on residency
    there would be no need to test on relationship. Consequently, officials
    gave a higher priority for testing residency certification.

    Second, IRS has changed the start date of the test twice. Originally, IRS
    planned to start the test in July 2003, but postponed implementation until
    mid-August. As we were finalizing this report, IRS announced in August
    that it now plans to begin the test in December 2003, in conjunction with
    the 2004 tax filing season. (Appendix IV shows key milestones from 2002
    through 2005.) According to IRS officials and documents, implementation
    was postponed from July to August to allow time to conduct focus group
    testing, request and obtain public comments during a 30-day period, and
    make changes to the program as a result of those efforts. Thereafter, IRS
    postponed implementation a second time from August to December to ensure
    (1) taxpayers have better access to tax practitioners since many only
    operate during the filing season and (2) more time for outreach and
    education.

    However, as a result of the delays, taxpayers will be providing proof of
    residency documentation during the filing season and not "precertifying"
    before the filing season as originally envisioned. This change is
    important and creates additional challenges for both IRS and taxpayers, as
    follows:

    o 	Taxpayers will no longer have the opportunity to provide proof of
    qualifying child residency, correspond with IRS in advance of the filing
    season, and resolve any potential issues before filing their tax returns.
    Because all correspondence will take place during the filing season,
    selected taxpayers could experience a delay in receiving the EIC portion
    of any refund, if the EIC portion is frozen because of any problems until
    certification is successfully completed.

    o 	IRS will no longer be able to spread out its workload and processing
    may be slower since certification will occur during the filing
    season---IRS's busiest time of year.

    o 	IRS will not have the opportunity to assess taxpayers' ease or
    difficulty in obtaining required documentation in advance of the filing
    season and whether taxpayers would do so. This is important because
    taxpayers may be given the opportunity to certify in advance of the filing
    season in future years.

    Third, IRS reduced the number of taxpayers included in the test from
    45,000 to 25,000, in part, in response to comments received during the
    30-day public period. According to IRS officials, despite reducing the
    number of taxpayers included in the test, the sample size should still
    allow IRS to make statistically valid measurements of results in addition
    to helping IRS meet its desired goals of protecting revenue and testing
    the process for conducting the certification program. In addition, the
    smaller sample should help mitigate the challenge related to processing
    the certification forms during the filing season.

    Process for Selecting Taxpayers, What They Will Receive, and What They
    Will Provide to IRS Remains Basically the Same

    Despite these changes, how IRS selected taxpayers for the test, what
    taxpayers will receive from IRS, and what taxpayers will be asked to
    provide as proof of residency for qualifying children will remain
    fundamentally the same. IRS's process for selecting the taxpayers for the
    test is shown in figure 2.15 Using this process, IRS selected 25,000
    taxpayers in August. The 25,000 represents about 0.16 percent of the
    approximately 16 million EIC claimants with a qualifying child in tax year
    2002 and about 0.13 percent of the approximately 20 million EIC recipients
    overall.

    15IRS will exclude from its sample taxpayers who are subject to an
    examination, investigation, or other treatment at the same time.

    Figure 2: IRS's Process to Identify the Population of Taxpayers from Which
    the 25,000 Person Test Sample Was Drawn

    aThe FCR contains custodial and welfare assistance data. If there is a
    match showing that the taxpayer is the child's custodian, regardless of
    the taxpayer's gender, filing status, or relationship to the child, IRS
    assumes the child resides with the taxpayer.

    bThese taxpayers are excluded, based on (1) IRS compliance data that show
    married filing jointly parents are 20 times more compliant on residency
    than nonparents, and single or head of household mothers are 10 times more
    compliant on residency than single or head of household fathers and (2)
    private studies that show about 90 percent of children in low income
    households live with their mother or both parents.

    cIRS estimates that using the FCR and other databases will exclude almost
    75 percent of the 1.6 million taxpayers. Therefore, about 402,000
    taxpayers were included in the population from which IRS drew the
    certification sample.

    According to agency officials, IRS will now send the 25,000 taxpayers
    forms and instructions about the program in December instead of this
    summer. IRS plans to send Notice 84-A, a letter informing them about the
    new program; Form 8836, "Qualifying Children Residency Statement;"
    Publication 3211M, "Earned Income Tax Credit Question and Answers;" and
    Publication 4134, "Free/Nominal Cost Assistance Available for Low Income
    Taxpayers." However, officials are changing these documents based on the
    public comments received. Appendix V has the most current copies of these
    documents.

    Once taxpayers receive this information from IRS, they would obtain
    documentation to prove the qualifying child's residency and send it back
    to IRS. IRS examiners would review the documentation and send a letter
    back to the taxpayer either accepting or rejecting the claim, as shown in
    figure 3.

    Figure 3: The EIC Certification Process as Envisioned

    IRS currently envisions that the 25,000 taxpayers selected for
    certification will be required to provide proof that the qualifying child
    meets residency requirements before getting the EIC portion of their
    refund. IRS officials

    say that taxpayers who are able to establish eligibility when filing their
    tax return should receive their refunds more expeditiously than those who
    do not. Taxpayers selected for certification but who are not able to
    provide the necessary documentation will be treated essentially the same
    as taxpayers undergoing a correspondence audit. The EIC portion of their
    refund-if they are to get one-will be frozen until proof of eligibility is
    established.

    Same Factors Considered When Setting Smaller Sample Size

    According to IRS's draft evaluation plan for the certification test and
    our discussions with officials, three factors were considered in setting
    the original sample size of 45,000: (1) show that certification would
    "protect revenue," (2) determine whether the test will succeed, and (3)
    test its processes and systems. According to IRS officials, the smaller
    sample size of 25,000 is designed to allow IRS to achieve the same goals
    as the original sample size, albeit to a lesser extent.

    One factor considered by IRS for the certification test was to stop as
    large an amount of EIC overclaims due to ineligible qualifying children as
    possible during the 2003 tax year. To determine how many taxpayers to
    include in the certification test to achieve this goal, officials said
    they determined the maximum number of staff that could be assigned to and
    adequately supported by the planned central unit in Kansas City that would
    be responsible for the certification program. Based on the maximum number
    of staff that could be assigned and assumptions about how many cases staff
    could handle, IRS calculated that 45,000 taxpayers could be included in
    the test. IRS estimated that $114.5 million in protected revenues could be
    realized from including 45,000 taxpayers in the test. Based on the revised
    sample size of 25,000, IRS now estimates that $63.6 million in protected
    revenues could be realized.

    A second factor considered was to have a large enough sample to support
    analyses of whether the test succeeds. For instance, IRS is interested in
    how many taxpayers provide the information needed for IRS to determine
    qualifying child eligibility, whether taxpayers in the sample population
    who are actually qualified to claim the EIC do not do so with their 2003
    tax return and why, and whether taxpayers found the certification process
    burdensome. IRS's draft plan for evaluating the certification test notes
    that the original 45,000 sample size was much larger than needed to obtain
    statistically valid measures of test results. The draft plan indicated
    that a sample size of about 3,600 taxpayers, which would have provided an
    estimate at 95 percent confidence levels plus or minus 5 percent, was the

    number of taxpayers needed for IRS to determine qualifying child
    eligibility. According to the draft plan, the 45,000 sample size would
    allow very precise estimates for the population as a whole and should
    provide statistically valid information about sub-sets of claimants.
    Despite the reduction to 25,000, IRS officials still believe that this
    sample size will allow for precise estimates for the universe as a whole
    and smaller subsets as well.

    Finally, a third factor in selecting both the 45,000 and 25,000 sample
    sizes was to have a large enough sample to test the processes and systems
    that would be required if IRS were to expand certification in the coming
    year. IRS had been preparing to work on approximately 25,000 certification
    cases during the filing season under its original plan for 45,000
    taxpayers. It based the 25,000 on worst case assumptions about how many of
    the 45,000 would not opt to submit proof of eligibility in advance of the
    filing season and, instead, would have submitted their documentation
    during the filing season. In addition, for this goal, the draft plan
    preceded IRS's current thinking that the certification program likely will
    not be expanded as rapidly next year, if expanded at all. However,
    according to IRS officials, based on the number of cases IRS estimates can
    be worked on and what it plans to achieve under this goal, the 25,000
    sample size is appropriate to help test the systems and processes.

    Future Expansion of Certification Program Depends on Test Results

    Although IRS has consistently referred to the certification effort as a
    test, officials recently have stressed this point. For example, officials
    have recently referred to the efforts for this year as a "pilot or proof
    of concept." Furthermore, as a result of the most recent changes, the
    program will no longer take place in advance of the filing season, but
    instead, during the filing season. IRS officials told us that it is
    unlikely that the certification program will be expanded to cover 2
    million claimants in the summer of 2004, as originally anticipated.
    Instead, IRS officials plan to assess the program's overall effectiveness
    and make any necessary modifications before expanding it to additional EIC
    claimants in the future. Thus, particularly in light of IRS's most recent
    announcement and according to IRS officials, the program may be expanded
    more slowly, if at all, depending upon the evaluation results. Officials
    also said that test results will contribute to a future decision about
    whether certification, if continued, will precede the filing season or be
    part of the filing season as it will be this year.

    Input from Focus Groups and Others Has Resulted in Changes and May Result
    in More

    On the basis of stakeholder input, focus groups, and other input, IRS has
    made several changes to the planned certification test in addition to
    those discussed previously. IRS held informal meetings with external and
    internal stakeholders, focus group meetings with taxpayers and paid
    preparers, and one-on-one interviews with third parties to share the
    certification letters, forms, and/or instructions and obtain views on
    aspects of the new process. In response, IRS took several actions,
    including revising the forms. As of August 2003, IRS was evaluating
    comments received during the 30-day public comment period, which IRS
    officials said may result in additional changes.

    IRS held several informal meetings with external and internal parties with
    an interest in the qualifying child certification program. In March 2003,
    the Stakeholder Partnership, Education, and Communication Organization16
    and the National Taxpayer Advocate held four informal meetings with
    various external stakeholders, such as representatives of the National
    League of Cities, the Boston EIC Coalition, and the American Institute of
    Certified Public Accountants. Similarly, IRS officials coordinated the
    certification initiative with internal stakeholders, such as
    representatives from the Compliance unit, Wage and Investment operating
    division, Small Business/Self Employed (SB/SE) operating division, and
    Forms and Publications unit. The purpose of these meetings was to discuss
    the EIC certification proposal and share the drafts of the two new
    certification tax forms-Form 8836, "Qualifying Children Residency
    Statement," and Form 8856, "Qualifying Child Relationship Statement."
    Officials told us they received comments from these groups of stakeholders
    and revised and improved the forms based on the feedback received. For
    example, for the residency form IRS added a list of community-based
    organizations and a list of acceptable third parties from which IRS would
    accept affidavits.

    After incorporating the recommendations from these informal meetings,
    officials said they felt comfortable with testing the Form 8836, its
    instructions, and the accompanying letter in other ways, including focus
    groups, one-on-one interviews, and a 30-day public comment period.17

    16 The Stakeholder Partnership, Education, and Communication Organization
    is a unit with IRS's Wage and Investment operating division. Its role is
    to educate and assist taxpayers before their returns are filed.

    17Before the focus groups commenced, IRS had decided to move forward only
    with the residency certification.

    In June 2003, a contractor conducted nine focus groups, five with
    taxpayers who claimed EIC in tax year 2002, and four with tax preparers
    who had prepared returns for taxpayers claiming EIC. In addition to the
    focus groups, the contractor also conducted nine one-on-one interviews
    with a cross section of the third parties listed on Part IV of the Form
    8836 (the participants were landlords, employers, and child care
    providers). The goal of the testing was to determine whether individuals
    understood the documents and thought they could obtain the requested
    supporting documents and whether the suggested third parties would be
    willing to sign the affidavit.

    The focus groups and interviews were held in Philadelphia, Chicago,
    Dallas, and Los Angeles. These cities were selected because of their high
    EIC population. The participants were selected using screening guidelines
    developed by IRS in conjunction with the contractor. Taxpayers were
    selected on the basis that they claimed the EIC for tax year 2002 with a
    qualifying child. Similarly, preparers were selected on the basis that
    they worked as a tax preparer on federal tax returns for 2002 and prepared
    tax returns for clients claiming EIC with a qualifying child. Those
    selected for one-on-one interviews represented a cross section of the
    types of individuals IRS deemed credible to provide affidavit information
    about the EIC claimant. In total, 816 people were contacted and 109 agreed
    to participate in the focus group testing. Of the 109, 88 persons arrived
    for the testing and 81 actually participated in the focus groups. For the
    one-on-one interviews, 12 individuals were qualified to participate and 9
    actually participated in the interviews.18

    Key IRS officials were on site during the focus groups and one-on-one
    interviews to observe the participants' comments. A variety of comments
    were received and some changes were made. For example, IRS highlighted
    where taxpayers and third parties were to sign the forms. Although the
    contractor's report of these meetings was not available before the public
    comment period, IRS officials who attended the meetings concluded that
    they had not received any feedback that would preclude moving forward with
    getting comments from the public.

    18According to IRS officials, approval from the Office of Management and
    Budget is required in situations where the agency conducts interviews with
    more than nine private sector participants. However, because conducting
    such interviews was suggested later in the process and because OMB had
    been briefed on the development of the certification test, IRS did not
    seek that approval.

    During the comment period, anyone could write or go to IRS's Web site and
    provide any comments or opinions about the qualifying child certification
    program, including the form IRS expected to use and the data it planned to
    request to prove eligibility. According to IRS, during the 30-day public
    comment period, IRS received about 200 communications containing comments.
    Any other comments about the certification program are due by December 31,
    2003. In addition, individuals can comment on the certification process
    during the filing season until April 15, 2004. As of August 2003, IRS
    officials were reviewing the comments received and anticipated making
    additional changes to the forms and publications shown in appendix V.

    Our Concerns with IRS's Recertification Were Considered as IRS Designed
    the Qualifying Child Certification Program

    IRS officials told us they considered the recommendations in our
    recertification report19 when planning their certification program. We
    agree that our applicable recommendations have been considered. Whether
    the strategies IRS adopted to deal with the concerns that led to our
    recertification report recommendations are successful will not be known
    until IRS evaluates the certification test.

    Our recertification report described three aspects of the recertification
    process that caused problems for taxpayers. Specifically,

    o 	one form used for recertification was of questionable value to IRS and
    another form was potentially confusing to taxpayers;

    o 	taxpayers were asked to submit information that was difficult for them
    to obtain or inconsistent with what many IRS examiners considered
    acceptable; and

    o 	IRS examiners' inconsistent assessment of documentation submitted by
    taxpayers could result in different recertification decisions for
    taxpayers in similar circumstances.

    IRS has taken steps to deal with all of these concerns in designing the
    certification process. Regarding the problems with recertification forms,
    the form that was of questionable value to IRS, which was essentially a
    means for taxpayers to tell IRS that they wished to be considered for

    19GAO-02-449.

    recertification, is not applicable to the certification program. The other
    recertification form told taxpayers what they had to submit to establish
    their eligibility for the EIC. We found that this form could confuse
    taxpayers into believing they had to show that a qualifying child was also
    their dependent, a criterion not applicable to EIC eligibility. We also
    found that the form provided insufficient guidance to taxpayers on what
    information they needed to provide to prove that qualifying children met
    the EIC eligibility requirements. We made several recommendations,
    including that IRS should clarify taxpayers do not need to demonstrate
    that qualifying children are also dependents, help taxpayers better
    understand what documentation they need to provide to establish their
    relationship with any qualifying children, eliminate a requirement that
    statements from child care providers be notarized, and encourage taxpayers
    to submit more than one type of documentation.

    Regarding our concerns about taxpayers who were recertifying being asked
    to submit documentation that was difficult for them to obtain and that tax
    examiners did not all accept, we found, for example, that EIC taxpayers'
    living arrangements could make providing various documents difficult. We
    also found taxpayers did not always understand that school records were
    for a calendar year and therefore needed to cover the spring and fall of
    separate school years. We also found situations in which IRS examiners
    would not accept a document even though the recertification form listed
    the document as being acceptable. This concern overlapped with our finding
    that IRS examiners' were inconsistent in their assessment of whether
    documentation provided by the taxpayers was sufficient to establish their
    qualifications for the EIC.

    Regarding our concerns about inconsistent documentation, IRS again took
    actions intended to deal with our concerns in developing the certification
    program. By introducing a new option-obtaining an affidavit affirming that
    a qualifying child resided with the taxpayer for more than half the
    year-IRS intended to give taxpayers another means of showing that the
    residency requirement is met, which would prevent the taxpayer having to
    obtain the other types of documents that the draft certification form
    lists. Although IRS did not, as we recommended, create a new form to be
    used by taxpayers when seeking school records, it did follow our
    alternative recommendation that IRS clearly remind taxpayers that they
    need records for part of 2 school years. The information is included in
    the certification form's instructions, which contain an example where a
    taxpayer must provide records from 2 school years. Finally, by
    centralizing the EIC certification processing in one location-Kansas
    City-and providing

    training to those who will be involved, IRS is seeking to ensure a higher
    level of consistency in how tax examiners judge whether taxpayers
    adequately establish that qualifying children meet the residency criterion
    for EIC.

    Whether the manner in which IRS took our recertification recommendations
    into account when designing the certification program will be successful
    will not be known until IRS evaluates the certification test.

    Qualifying Child Certification Program Developed to Improve Compliance
    While Considering Taxpayers' Burden, but Plan for Evaluating Test Is
    Incomplete

    The certification program appears to be adequately developed to
    potentially improve EIC compliance with consideration for minimizing
    taxpayer burden so that testing should proceed, particularly in light of
    IRS's recent announcement further delaying the program's start and
    reducing the sample size. For example, the EIC task force and IRS have
    taken steps that directly minimized the number of taxpayers who will be
    burdened by the certification program. That is, the certification proposal
    is based on analyses of the leading sources of EIC errors detected in
    earlier studies, thus focusing attention and burden on the subset of
    taxpayers making those errors, as opposed to all EIC recipients. In
    addition, IRS has taken steps to address the burden taxpayers will
    experience as participants in the certification test this year.

    Although IRS has made and is continuing to make progress in defining its
    plan to evaluate the certification test, the plan is incomplete. For
    example, the draft plan does not indicate how and when some information
    that will be needed to evaluate whether certification achieves its
    objectives will be obtained and analyzed. However, officials recognize the
    draft plan needs to be further developed and the importance of doing so
    quickly.

    Initial Design and Subsequent Changes May Improve EIC Compliance and Have
    Helped to Minimize Burden

    In initially designing and subsequently modifying the EIC certification
    program, officials took into account the burden that taxpayers may
    experience while attempting to improve compliance. Officials designed the
    program to include, and thus burden, only the taxpayers most likely to
    make the errors that contribute most to the EIC's overclaim rate. By
    focusing on these noncompliant taxpayers, IRS expects to improve EIC
    compliance. In addition, officials took a number of steps, such as
    obtaining input from external and internal stakeholders that resulted in
    changes and delaying the program while considering comments received
    during the

    comment period, which should reduce the burden on those taxpayers who are
    identified to certify.

    To help improve compliance, the task force focused on known sources of
    noncompliance including claiming nonqualifying children, filing status,
    and misreporting income. To deal with errors attributable to claiming
    nonqualifying children, the task force proposed a program for certifying
    the eligibility for qualifying children and envisioned targeting taxpayers
    most likely to make those errors. In contrast, other benefit programs that
    we reviewed generally require all applicants to provide documentation
    before receiving assistance. For example, to receive Supplemental Security
    Income, an individual must visit a Social Security office, meet with a
    representative, and provide documentation including birth certificates and
    payroll information. The Social Security Administration then matches this
    information to determine eligibility in advance of benefits being
    received. IRS's certification effort, even if fully implemented, would
    require only a subset of all EIC taxpayers to provide documentation to
    support their eligibility and only when IRS is unable to verify
    eligibility from other sources of information.

    After the proposal was formally adopted, IRS took a number of steps in
    developing plans for implementation that have been intended at least in
    part to minimize the burden that taxpayers actually asked to certify would
    experience, including the following.

    o 	IRS has undertaken more activities than usual to ensure the residency
    form and other explanatory documents related to the certification program
    have been reviewed by those who would use them. 20 IRS sought feedback
    from focus groups and stakeholders on various aspects of the certification
    test and the draft letter, form, and instruction proposed for the
    residency test, such as whether taxpayers will be able to obtain and
    provide documents within the time available, and made some changes to the
    proposed form due to that feedback. As previously described, IRS held
    focus groups with taxpayers, paid tax preparers, and other parties to
    obtain feedback on certification. Officials also interviewed a small
    number of third parties who would be called upon

    20 IRS generally tests few forms and instructions with taxpayers before
    using them. See U.S. General Accounting Office, Tax Administration: IRS
    Should Reassess the Level of Resources for Testing Forms and Instructions,
    GAO-03-486 (Washington, D.C.: Apr. 11, 2003).

    to provide requested documents. IRS also held a 30-day open period to
    receive comments from any interested party and expects to revise
    certification materials due to comments received. Finally, IRS officials
    say they will again revisit, among other things, the appropriateness of
    the forms and explanations going to taxpayers after evaluating the results
    of this year's test of certification.

    o 	IRS considered the issues we raised in our report about the
    recertification program21 when planning for certification. For example, as
    discussed previously in this report, IRS developed a standard form that
    includes an affidavit, which taxpayers can provide to third parties, such
    as an employer, as an alternative to obtaining other documents to prove
    residency. We also noted in our report that examiners inconsistently
    accepted or declined supporting documentation for recertification
    purposes. To address this concern, IRS officials conducted special
    training and have all certification examiners in one location, Kansas
    City, where EIC claims will be processed.

    o 	IRS provided taxpayers with a variety of documentation choices in order
    to prove eligibility for their qualifying children. To certify for
    residency, taxpayers will need to provide Form 8836, "Qualifying Children
    Residency Statement," with one or more of the following supporting
    documents:

    o 	school records, medical records, day care provider records, leases, or
    social service agency records that show the parent's name and the child's
    name and address, and the dates that the child lived with the parent; or

    o 	a letter on official letterhead for a qualifying child from the child's
    school, health care provider, landlord, or member of the clergy that shows
    the parent's name and the child's name and address, and dates that the
    child lived with the parent; or

    o 	a third party affidavit from a clergy member, community-based
    organization official, health care provider, landlord or property manager,
    school official, or day-care provider.

    21 GAO-02-449.

    o 	IRS dropped for an undetermined period of time, its plan to ask
    taxpayers to certify their relationship to qualifying children. IRS
    officials do not know whether or if they will test certification of
    relationships in the future. Various external stakeholders had expressed
    concerns about whether taxpayers would be able to provide the type of
    documents, such as marriage and birth certificates, which IRS had planned
    to request to document relationships to qualifying children on time. Also,
    IRS officials said that the relationship portion of the program was
    dropped for other reasons, including that (1) studies that have shown
    relationship requirements to be less of a compliance issue than residency
    and (2) taxpayers found to be noncompliant because of relationship
    requirements often were also noncompliant due to residency errors. As a
    result, certification will only include residency this year.

    As part of its effort to balance burden with ensuring compliance, IRS made
    the changes listed above. As we drafted this report, it had not yet
    determined what additional changes it would make to the forms on the basis
    of comments received during the 30-day public comment period, but
    officials said more changes will likely result. As previously discussed,
    the initial design of the residency form was responsive to concerns we
    raised in our earlier report on IRS's recertification program. Additional
    changes, especially dropping relationship recertification, were responsive
    to the concerns that stakeholders raised before the public comment period.
    Accordingly, the current draft residency certification form addresses many
    burden concerns.

    IRS's Plan for Evaluating the Test Is Incomplete

    Although IRS has made and is continuing to make progress in defining its
    plan to evaluate the certification test, the plan is not yet complete.
    From its inception, the certification program was intended to: (1) reduce
    the EIC's overclaim rate, (2) minimize burden on taxpayers and (3)
    maintain the EIC's relatively high participation rate. Although there are
    many ways to organize an evaluation, determining whether the major
    objectives of a program are accomplished should help policymakers
    determine whether and how to proceed with the program. The draft plan is
    not explicitly organized to show whether certification's objectives are
    achieved, but does present some information on how IRS would evaluate
    these objectives. However, the plan proposed potential options for
    identifying how and when some critical data will be obtained and analyzed,
    but does not provide further details on when decisions will be made on
    specific data that will be collected, how, and by whom. Officials
    recognize that the draft plan

    needs to be further developed and the importance of doing so quickly. They
    have, for instance, developed preliminary drafts identifying additional
    data needed and have begun considering how to use contractors to gather
    the data. Because evaluating these objectives will depend in part on
    actions of EIC certification participants that will now occur as part of
    next year's filing season, IRS appears to have some time before it must
    make final decisions on how it will determine whether the objectives were
    met.

    Although an evaluation plan may not have to completely identify all issues
    that need to be evaluated and precisely how they will be evaluated before
    a program begins, the more completely such a plan is developed before a
    program is implemented, the more likely that the evaluation will be
    sufficient to support future decisions. For example, identifying key
    questions that need to be answered before a project's implementation
    increases the chances that necessary data will be collected to answer
    those questions. IRS's Internal Revenue Manual22 recognizes the
    desirability of having evaluation plans in place before a project is
    implemented. For instance, it requires such plans before reorganizations.

    IRS has been preparing an evaluation plan for the certification test and
    has a draft plan, dated April 22, 2003. That draft describes how IRS
    expects to evaluate the program and the process IRS used to select
    taxpayers for the test.

    The draft plan identifies one "threshold" question for evaluating the
    certification program: whether the claimant selected for the test provided
    the required information to allow IRS to determine the eligibility of
    qualifying children regardless of whether the claimant was determined to
    be eligible or not. The plan lists data that are to be gathered throughout
    the certification program to answer this question.

    The threshold question is part of what must be included in determining
    whether certification for residency helps lower EIC overclaims, but
    additional information is needed. Although not tying methodologies or
    planned data collection specifically to whether certification lowers the
    EIC overclaim rate, the draft plan has a combination of approaches that
    should contribute to answering this question. For example, the draft plan
    identified data that IRS would gather throughout the test on how many
    taxpayers in the test sample certify or fail to do so in advance of the
    filing

    22See Internal Revenue Manual 1.1.4 and 1.2.1.

    season as well as how many prove that children meet the EIC residency test
    during the filing season.23

    The extent to which certification may reduce overclaims due to qualifying
    children not meeting the residency requirement, however, will depend
    significantly on why some taxpayers will not attempt to certify and why
    some will fail to claim the EIC, or as much EIC, for tax year 2003 as they
    did for 2002. The draft plan takes into account that some taxpayers may
    receive the certification materials, determine that a child does not meet
    the residency test, and therefore not attempt to certify and not claim the
    EIC with their 2003 tax return or claim EIC on another basis. IRS expects
    to use available data to help assess whether the taxpayer had a filing
    requirement and whether the taxpayer may have been eligible to claim the
    EIC (e.g., did the taxpayer's income fall within the appropriate range?).
    In addition, the draft plan proposes that IRS use a contractor or another
    third party to gather information from taxpayers about why they did not
    claim the EIC. A subsequent document cites ideas for the types of
    questions that could be asked.

    Regarding the burden certification imposes on taxpayers who participate,
    the plan is not organized to show how this will be evaluated, but it
    recognizes that participants' burden should be evaluated. For example, the
    data IRS plans to collect throughout the process will have some utility in
    answering this question. IRS will keep track of the number of
    communications back and forth between IRS and the taxpayer before a tax
    examiner makes a final certification decision. IRS's plan also recognizes
    that some information on burden will need to be collected directly from
    taxpayers. The plan includes a general description of a potential opinion
    survey that would gather burden-related information from certification
    participants. Little or no detail is provided on how taxpayers would be
    selected for such a survey, what types of questions would be asked, and
    when the survey would be done; however, some of this information is shown
    in a subsequent draft document. Because taxpayers will not have completed
    their certification experience until sometime next filing season, IRS has
    some time to decide whether to do such a survey and how to define its
    parameters.

    23IRS's draft evaluation plan preceded its decision to test certification
    during the 2004 filing season. These data will now need to be collected
    during the filing season.

    Regarding the objective of maintaining the EIC's relatively high
    participation rate, the draft plan proposes to obtain information from
    those taxpayers who are asked to certify, do not, and then fail to claim
    the EIC. The plan proposes to use a contractor or other third party to
    gather information from these taxpayers about why they did not claim the
    EIC. The plan does not amply describe how and when final decisions would
    be made about selecting contractors or another third party to do this,
    when the contractor would contact taxpayers, or what data they would
    attempt to obtain from the taxpayers. Because the population IRS will need
    to contact for these surveys will not be known until during and after the
    spring of 2004, IRS has a number of months to further develop and
    implement an approach.

    Recognizing that its plans need to be further developed, IRS officials
    have continued to explore how the evaluation will be done. For example,
    officials have drafted ideas for the type of survey questions a contractor
    or other party would ask of EIC taxpayers to help IRS assess why taxpayers
    take, or do not take, various actions (such as why they may stop claiming
    the EIC after being asked to certify eligibility) and to assess taxpayers'
    experiences under the certification program, including the burdens they
    experience. In addition, officials have begun identifying potential
    contractors who would perform the surveys and considering contracting
    options. According to IRS officials and documents, some discussions have
    been held with potential contractors to gain a better understanding of
    ways to test the survey instruments, techniques available to ensure the
    best possible response rate, and the number of taxpayers needing to be
    contacted to have useful results.

    Finally, because IRS would like to undertake some version of the
    qualifying child program next year, possibly including certification
    during the latter part of 2004, the timely production of evaluative data
    for this year's test will be critical for supporting decisions about what
    form future efforts will take. IRS is aware of the tight schedule.
    Officials note that while they will not have complete information on which
    to base some decisions about whether and how to continue with
    implementation in 2004 before those decisions must be made, they expect to
    have preliminary data in a timely fashion. For example, IRS will not be
    able to completely answer whether, and if so, why, taxpayers who are
    legitimately qualified to receive the EIC do not claim it when they file
    their 2003 tax return until the end of the 2003 tax filing season, or
    later if taxpayers request a filing extension. IRS does expect that its
    contractor will have contacted many, if not most, of the taxpayers who
    file returns before the end of the filing season and do not

    claim EIC. Thus, IRS expects to know during the fall of 2004 why many
    taxpayers in the certification test stop claiming the EIC.

    Some Implementation Issues Not Reviewed

    We did not evaluate some implementation issues because they were outside
    the scope of our review, still under development, or the Treasury
    Inspector General for Tax Administration had audits planned in these
    areas. Nonetheless, implementation issues could affect whether IRS is able
    to fully implement the certification test and ultimately improve
    compliance. We did not assess (1) whether IRS assigned an appropriate
    number of staff to assist taxpayers with questions and process the forms
    and documents relating to certification, (2) the adequacy of training
    materials for staff or the procedures put in place to help examiners
    consistently accept or decline taxpayers' supporting documentation, (3)
    the design or reliability of the databases that will be used to capture
    and evaluate program information, and (4) supporting tools, which
    examiners will use to do their job.

    IRS has developed broad plans for processing the certification workload.
    Officials identified about 30 different offices that will be affected by
    the new certification program. As a key part of its processing strategy,
    IRS plans to dedicate employees at its Kansas City campus to process
    cases, answer a special toll-free number, and make updates to a
    certification database based on responses from the test of the 25,000
    taxpayers. The Kansas City site will have about 180 staff, the bulk of
    whom will come on-board between September and December 2003. Approximately
    40 staff took initial training between April and June 2003.

    Conclusions	Given the persistently high EIC overclaim rates, that the
    certification program is a test, and that IRS has taken key steps to
    address burden issues and focus the test on individuals least likely to
    meet the qualifying child residency requirements, we believe IRS has
    struck a reasonable balance between preventing unreasonable burden on EIC
    taxpayers and balancing the need to obtain information on whether
    certification can be a useful approach to improving EIC compliance. In
    addition, with the recent program changes announced in August, it appears
    that IRS is taking even more steps to be mindful of these concerns.
    Although certification during the 2004 filing season gives IRS somewhat
    more time to modify the forms and take other actions to potentially
    further reduce the burden on taxpayers subject to the test, it also
    creates new challenges for IRS. The

    test will no longer be a direct test of the original concept of certifying
    taxpayer eligibility in advance of the filing season. Instead, testing
    will occur during the filing season-IRS's busiest time of year-and gives
    IRS only indirect evidence on how well certification may work before the
    filing season as originally envisioned. Further, because IRS currently
    plans for taxpayers to have to successfully provide proof of eligibility
    when they file their individual income tax return or have a refund frozen
    until they do, a greater portion of the taxpayers chosen for the test may
    have their refunds delayed than if certification had been done before the
    filing season. Finally, like virtually all aspects of the qualifying child
    certification program, IRS's future plans have yet to be determined and
    are largely dependent of the results and subsequent evaluations of this
    test.

    For various reasons, we did not review in detail some implementation
    issues, such as staffing and procedures for handling taxpayer responses,
    which could affect whether IRS is able to successfully implement the
    certification test. Thus, our opinion on whether IRS is ready to proceed
    is based only on whether it has adequately developed the test to prevent
    unreasonable burden and to improve compliance.

    Although the balance IRS has struck supports proceeding with the test,
    IRS's plan for evaluating the certification program test is incomplete.
    IRS recognizes the need to evaluate the test and is developing its plan to
    do so. For some key test objectives, IRS has preliminarily identified some
    data that it believes must be collected to determine whether
    certification's objectives are achieved and has broadly identified when
    and how that information will be collected. Because the data are related
    to taxpayers' actions that will occur later this year or next spring, IRS
    appears to have some time to finalize its evaluation plan.

    Recommendations for Executive Action

    Given that the qualifying child certification program is a key part of
    IRS's plans for reducing EIC overclaims and that certification is intended
    to help reduce overclaims while minimizing the burden on taxpayers and
    maintaining the EIC's participation rate, the Commissioner of Internal
    Revenue should, to the extent possible, accelerate development of the
    evaluation plan for the test. The plan should demonstrate how each of the
    certification's objectives will be evaluated, including milestones for
    such critical steps as defining the specific data that will be collected,
    who will collect the data, and how the data will be analyzed in time to
    support decisions about the future of the program.

    Agency Comments and Our Evaluation

    While not explicitly agreeing with our recommendation, in his September
    22, 2003, letter, the Commissioner of Internal Revenue said that IRS would
    be including the components we suggested in their evaluation plan and said
    that IRS is working to incorporate these components well before the
    certification test begins. The Commissioner said that our discussion of
    the evaluation plan is essentially accurate, but provided an enclosure to
    his letter that noted supplemental information on the plan. We are aware
    of the information described in the enclosure to the Commissioner's
    letter, and considered it when drafting our report.

    The Commissioner also raised concerns about the comparability of EIC error
    rates to the error rates in taxpayers' reporting of certain types of
    income. We concurred that, by-and-large, the compliance data on reporting
    of these types of income are not comparable to the EIC error rate. As a
    result, we no longer show those comparisons in our final report.

    We are sending copies of this report to the Chairmen and Ranking Minority
    Members of the Senate Committee on Finance and the House Committee on Ways
    and Means. We are also sending copies to the Secretary of the Treasury;
    the Commissioner of Internal Revenue; the Director, Office of Management
    and Budget; and other interested parties. We will make copies available to
    others on request. In addition, the report will be available at no charge
    on the GAO Web site at http://www.gao.gov.

    This report was prepared under the direction of Joanna Stamatiades,
    Assistant Director. Other major contributors are acknowledged in appendix
    VII. If you have any questions about this report, contact Ms. Stamatiades
    at (404) 679-1900 or me on (202) 512-9110.

    Michael Brostek Director, Tax Issues

    Appendix I

    Significant Noncompliance Rates Other Than for the EIC

    The IRS has compliance data on some taxpayer groups such as individuals
    and small businesses and some tax items such as income and credits.
    By-and-large, the compliance data IRS currently has are not comparable to
    the EIC. IRS is implementing its National Research Program (NRP), which
    will provide new compliance data in 2004. In the meantime, IRS is using
    its Strategic Planning and Performance Management process to prioritize
    compliance issues.

    The compliance data that IRS has available for some taxpayer groups and
    tax items are largely based on the Taxpayer Compliance Measurement Program
    (TCMP),1 which was last conducted in 1988. However, these data cannot be
    compared to the EIC overclaim or error rates, in part because these data
    are 15 or more years old and reliable inferences cannot be drawn because
    much of the tax system and the economy have changed during that time. In
    addition, the methods used to calculate compliance rates for TCMP are
    different than those used to calculate EIC.

    In late 2002, IRS began implementing its new NRP, a detailed study of
    individual taxpayers' compliance.2 As part of NRP, IRS has identified a
    random sample of approximately 47,000 returns from tax year 2001 and is in
    the process of verifying the information on the returns through reviews of
    IRS and third-party data. Where necessary to confirm the accuracy of
    taxpayer-reported information, IRS is conducting either correspondence or
    face-to-face examinations. IRS intends to conduct additional NRP reviews
    of additional types of taxpayers, such as small corporations, and use the
    NRP periodically to measure compliance of individual taxpayers.

    The NRP sample of 47,000 returns includes about 7,300 EIC returns. These
    EIC returns are subject to the same processes as the other returns in the
    sample, and will include a review of the taxpayers' eligibility for the
    EIC. In order to determine whether the NRP review of these returns will
    yield results methodologically similar to those of the 1999 EIC compliance
    study, IRS is also comparing the results of the 1999 compliance study with
    NRP by putting a sample of returns from the 1999 study through NRP
    processes

    1For almost 30 years, the Taxpayer Compliance Measurement Program was
    IRS's method for statistically estimating the voluntary compliance of
    taxpayers in reporting their tax obligations.

    2Among other things, IRS plans to use NRP data to update the formulas used
    to select tax returns for examination and allow it to design programs that
    will help taxpayers comply with tax laws.

    Appendix I
    Significant Noncompliance Rates Other Than
    for the EIC

    (not including examinations). According to IRS officials, this should
    allow them to see the impact of the methodological differences between the
    compliance study and NRP review. IRS expects the results of the comparison
    study by September 2003. IRS plans to have preliminary NRP results in May
    2004 and final results in November 2004.

    Until better compliance measurement data are available, IRS's
    organizational divisions use the Strategic Planning Budgeting and
    Performance Management process to prioritize the compliance problems IRS
    faces. Through this process, IRS says that it (1) identifies and explores
    critical trends, issues, and problems, (2) develops operational priorities
    and improvement projects to address existing or emerging problems, (3)
    explores drivers of program resources in order to develop resource
    allocation targets for carrying out the proposed strategies, and (4)
    enables division commissioners and the senior leadership teams to
    prioritize the strategies and projects and determine the resource
    requirements to apply to each strategy, operational priority, and
    improvement project.

    Based on managers' judgments made during this process, the Small
    Business/Self Employed (SB/SE) operating division, for example, identified
    its top six compliance priorities for fiscal year 2003 and 2004:

    o  high income nonfilers (income greater than $100,000),

    o  abusive offshore financial transactions,

    o  promoter investigations (those selling tax schemes to others),

    o  abusive tax avoidance transactions,

    o  high income taxpayers (income greater than $1 million), and

    o  returns with a high probability of unreported income.

    SB/SE, which conducts few examinations of EIC claims, did not consider EIC
    in this prioritization exercise since EIC has its own dedicated
    appropriation.3 Because IRS used different means to identify and
    prioritize these potentially noncompliant taxpayer groups, their
    identification as

    3Personnel in IRS's Wage and Investment operating division conduct the
    majority of EIC examinations.

    Appendix I
    Significant Noncompliance Rates Other Than
    for the EIC

    SB/SE priorities does not mean their noncompliance rate is comparable to
    noncompliance rates established for EIC or rates, which will be determined
    through the current or future NRPs or other EIC compliance studies.

    Appendix II

    Overclaim Rates, Administrative Costs, and Eligibility Verification
    Processes of Benefit Programs

    In addition to the data we complied on IRS's EIC and qualifying child
    certification program, we also compiled overclaim rate and administrative
    cost data, as well as information on the eligibility verification
    processes, for nine other federal or state benefit programs. We selected
    the nine benefit programs because each requires some type of certification
    for benefits, similar to the EIC, and because the EIC task force reviewed
    the same programs. We did not do a comprehensive analysis to determine
    which programs, if any, are most comparable to the EIC, nor did we
    determine whether the information reported is comparable across programs.

    The overclaim rates, administrative costs, and the eligibility
    verification processes for the EIC and the other nine benefit
    programs--Unemployment Insurance, Supplemental Security Income, Social
    Security Disability Insurance, the National School Lunch program, the Food
    Stamp program, Housing and Urban Development rental assistance, Medicaid,
    Medicare, and Temporary Assistance for Needy Families--are shown in table
    4.

    Overclaim rates for programs other than the EIC for which data were
    available ranged from 0.2 to 10.7 percent. These overclaim rates reflect
    the percentage of total dollars paid out in error, not, for example, the
    percentage of claimants who made errors.1 To calculate the overclaim
    rates, most of the nine agencies selected a sample of program participants
    and conducted a detailed analysis of the cases. This can involve
    collection of additional supporting documentation, personal contacts with
    employers and other third parties, or home visits to program recipients. A
    description of how the overclaim rates were calculated is in table 5.

    Administrative costs range from $123 million to $11.9 billion for the nine
    programs. Administrative costs reported by federal agencies are likely not
    comparable across programs and may not include all of the costs involved
    in administering the programs. For example, various agencies and entities
    at the federal, state, and local levels have administrative
    responsibilities under the National School Lunch program. However, while
    the federal budget provides funds separate from program dollars to pay for
    administrative processes at the federal and state level, officials at the
    local

    1We use the term overclaim rate to be the total excess payments made in
    error. This is generally referred to as the error or overpayment rate in
    the other programs we reviewed.

                                      Appendix II
                       Overclaim Rates, Administrative Costs, and
                     Eligibility Verification Processes of Benefit
                                        Programs

    level pay for administrative costs from program dollars that include
    federal and state funding and student meal payments.2

    The process used to determine and validate eligibility varies
    significantly. Some programs, such as the school lunch program, rely
    primarily on self-reported information and verification is limited. Other
    programs, such as the Food Stamp program, require program staff to conduct
    extensive verification.

    Table 4: Overclaim Rates, Administrative Costs, and Eligibility
    Verification Processes for EIC and Other Programs

    Program Overclaim ratea Administrative cost Eligibility verification
    process
    Earned Income Credit 27-32 percent $145 millionb Currently, no
    certification requirement exists. An EIC claimant's

                            (tax year 1999) (tax year 1999)

    return is selected for examination when it meets certain selection
    criteria that points to potential overclaim. When this occurs,
    documentation is generally requested to establish requirements for EIC and
    related issues using document request forms including for qualifying
    child, filing status, and dependency issues.

    Unemployment  8 percentc  $2.3 billiond       Eligibility for unemployment
                                                 insurance benefits is determined
                    (fiscal year  (fiscal year            under state law, so the
        Insurance          2001)     2001)             information applicants are
                                                                      required to
                                                provide varies by state. States
                                                rely heavily on self-reported
                                                information; in some states
                                                applicants can apply over the
                                                telephone or on-line. Only a
                                                limited number of states
                                                independently verify claimants'
                                                identity by using the Social
                                                  Security Administration's State
                                                   Online Query system, which can
                                                match a claimant's name, date of
                                                birth, and Social Security
                                                           number. States may use
                                                       independent automated data
                                                                          sources
                                                      to verify other eligibility
                                                        factors such as wages and
                                                                       employment
                                                             status.

    2See, for example, U.S. General Accounting Office, School Meal Programs:
    Estimated Costs for Three Administrative Processes at Selected Locations,
    GAO-02-944 (Washington, D.C.: Sept. 25, 2002).

                                      Appendix II
                       Overclaim Rates, Administrative Costs, and
                     Eligibility Verification Processes of Benefit
                                        Programs

                             (Continued From Previous Page)

      Program Overclaim ratea Administrative cost Eligibility verification process

    Supplemental 7.2 percente $2.8 billione Security Income (fiscal year 2001)
    (fiscal year 2002) Supplemental Security Income is available to
    individuals who are blind or disabled and poor. The amount of Supplemental
    Security Income an individual receives depends on several factors
    including, but not limited to, other sources of income and living
    arrangements. To apply for Supplemental Security Income, applicants must
    visit a Social Security office and meet with a Social Security
    representative. Examples of documentation required under the program
    include: (1) social security card; (2) birth certificate or other proof of
    age; (3) mortgage or lease; (4) payroll slips, bank books, insurance
    policies, and other records about income and assets; (5) names and
    addresses of doctors (if disabled); and (6) proof of United States
    citizenship or noncitizen status. To verify this information, the Social
    Security Administration uses computer matches to compare Supplemental
    Security Income records against recipient information contained in records
    of third parties, such as other federal and state government agencies. The
    Social Security Administration periodically conducts "redetermination"
    reviews to verify eligibility factors such as income, resources, and
    living arrangements. Recipients' eligibility is to be reviewed at least
    every 6 years.

                                                     Social Security Disability
    Social Security  0.2 percente  $2.0 billione  Income provides income
                                                     support
          Disability    (fiscal year   (fiscal year  benefits to former workers
          Insurance     2001)             2001)      who have suffered a
                                                     long-term
                                                       disability. Applicants can
                                                          start their application
                                                               online, but before
                                                     they are approved for
                                                     benefits, applicants must
                                                     provide the
                                                     following documentation to a
                                                      social security office: (1)
                                                                         a Social
                                                     Security number; (2) birth
                                                     certificate or other proof
                                                     of age;
                                                     (3) medical information,
                                                     such as names and addresses
                                                     of
                                                     doctors and medical records;
                                                         (4) work history for the
                                                                         prior 15
                                                     years; and (5) a W-2 or tax
                                                               return.

    School Lunch Not known $123 millionf   Households submit applications with
                                                       self-reported information,
                               (fiscal year      including the names of household
                                  2002)                members and all sources of
                                             income for each household member,
                                             and the Social Security
                                             number of the adult that signs the
                                             application. Alternatively,
                                               children with Temporary Assistance
                                                       for Needy Families or Food
                                             Stamp case number can be certified
                                             directly. Generally, no
                                              documentation or additional support
                                                      is requested at the time of
                                             application. Local authorities
                                             verify eligibility for free and
                                              reduced price meals for a sample of
                                                        applications using either
                                                  random or focused sampling
                                                         techniques.

                                      Appendix II
                       Overclaim Rates, Administrative Costs, and
                     Eligibility Verification Processes of Benefit
                                        Programs

                             (Continued From Previous Page)

      Program Overclaim ratea Administrative cost Eligibility verification process

    Food Stamps	8.66 percentg $2.4 billionh (fiscal year 2001) (fiscal year
    2002) Food Stamp applicants are asked to provide documentary evidence of
    household assets, income, and allowable deductions, as well as proof of
    noncitizen status. Allowable deductions may include housing and utility
    expenses, medical expenses, and child support payments. If documentary
    evidence is not available, state agencies may use other means of verifying
    information provided by applicants, including contacting third parties.
    State agencies are required to verify certain information on income and
    deductions and states may opt to require verification of additional
    information. State agencies may establish their own standards for the use
    of verification subject to the parameters specified in federal
    regulations.

                                                          Applicants must provide
    Housing and Urban  10.7 percenti  $945 millionj   third party verification
                                                                 of the following
                          (fiscal year    (fiscal year  factors: (1) family
    Development rental 2001)              2001)      annual income, (2) value
                                                        of assets, (3)
           assistance                                   expenses related to
            programs                                    deductions from annual
                                                        income, and
                                                        (4) other factors that
                                                        affect the determination
                                                        of adjusted
                                                         income. Housing agencies
                                                        may require documentation
                                                                          or they
                                                         may verify self-reported
                                                        information by telephone.
                                                                       Individual
                                                                 housing agencies
                                                              determine their own
                                                         verification procedures.

    Medicaid Not known	11.9 billionk (fiscal year 2001) Medicaid provides
    health insurance coverage to certain low income adults and children in a
    program jointly administered and funded by the federal government and the
    states. While the Social Security Administration sets the income threshold
    for Supplemental Security Income-related Medicaid eligibility annually,
    most Medicaid eligibility requirements and verification procedures are
    determined at the state level and vary by state. For example, some states
    require applicants to provide documentation of both income and allowable
    deductions, such as child care expenses and child support payments. Other
    states require applicants to provide information on income and deductions
    but do not require further documentation. Federal law requires that
    Medicaid applicants provide a Social Security number, unless the applicant
    refuses to obtain a number because of well established religious
    objections. While states are required to establish procedures for the
    periodic redetermination of a recipient's Medicaid eligibility at least
    annually, the procedures may vary by state.

    Medicare	6.3 percentl 4.4 billionm (fiscal year 2002) (fiscal year 2001)
    The Centers for Medicare and Medicaid Services administers the Medicare
    program; however, the Social Security Administration determines
    entitlement to Medicare benefits. Retired recipients who are receiving
    retirement benefits from Social Security or the Railroad Retirement Board
    are automatically enrolled in Medicare the month they turn 65. Individuals
    who are under age 65 and disabled are also automatically enrolled in
    Medicare after they have been receiving Social Security or Railroad
    Retirement disability payments for 24 months. All other individuals (e.g.,
    retired individuals who are not eligible for Social Security and
    individuals who have end stage renal disease) are required to file a
    Medicare application at a Social Security office.

                                      Appendix II
                       Overclaim Rates, Administrative Costs, and
                     Eligibility Verification Processes of Benefit
                                        Programs

                             (Continued From Previous Page)

    Program Overclaim ratea Administrative cost Eligibility verification
    process

    Temporary Not yet Available $2.3 billionn Eligibility requirements are
    determined at the state or local level,
    Assistance for Needy and therefore vary by state and locality.
    Families

    Source: GAO analysis of multiple agency data.

    aSee table 6 for information on how overclaim rates were calculated for
    each program.

    bIRS does not know the full cost of administering the EIC; for example,
    the $145 million does not include the cost of processing EIC returns.

    cUnited States Department of Labor Benefit Accuracy Measurement data.

    dUnited States Department of Labor.

    eSocial Security Administration, Performance and Accountability Report,
    fiscal year 2002.

    fUnited States Department of Agriculture Food and Nutrition Service.
    Includes state expenses for administering the School Breakfast Program,
    the Child and Adult Care Food Program, and the Special Milk Program.

    gUnited States Department of Agriculture Food and Nutrition Service,
    Quality Control Division.

    hUnited States Department of Agriculture Food and Nutrition Service.

    iHousing and Urban Development's Audit of Financial Statements Fiscal Year
    2002 and 2001, 2003-Fiscal Year 2004 (January 31, 2001), Note 17, p.
    104ff.

    jDepartments of Veterans Affairs and Housing and Urban Development, and
    Independent Agencies Appropriations for 2003, Hearings. 552-070-28357-9,
    p.106.

    kHealth and Human Services' Financial Management Report, fiscal year 2001.

    lHealth and Human Services' Office of Inspector General, Improper Fiscal
    Year 2002 Medicare Fee-For-Service Payments A-17-02-0220, (January 2003).

    mThe Boards of Trustees, Federal Hospital Insurance and Federal
    Supplementary Medical Insurance Trust Funds, 2003 Annual Report of the
    Boards of Trustees of the Federal Hospital Insurance and Federal
    Supplementary Medical Insurance Trust Funds. Administrative cost figure
    includes administrative costs for both Federal Hospital Insurance and
    Federal Supplementary Medical Insurance Trust Funds. Administrative costs
    for Hospital Insurance include the costs of experiments and demonstration
    projects as well as fraud and abuse control expenses.

    nHealth and Human Services' Administration for Children and Families,
    Temporary Assistance for Needy Families Program Fifth Annual Report to
    Congress. (February 2003).

    To the extent known, how the overclaim rates are calculated, for the nine
    benefits program we reviewed, including EIC, is shown in table 5.

                                      Appendix II
                       Overclaim Rates, Administrative Costs, and
                     Eligibility Verification Processes of Benefit
                                        Programs

    Table 5: How Overclaim Rates Are Calculated for Selected Benefit Programs

                       Program How overclaim rates are calculated

    Earned Income Credit	Compliance study based on audits of a statistically
    representative sample of taxpayers and adjustments made to their tax
    returns.

    Unemployment Insurance	The quality assurance system is used to estimate
    overpayments based on a statistically valid sample of Unemployment
    Insurance claims from each state. Investigators conduct detailed,
    comprehensive analyses of each case by personally contacting employers,
    claimants, and third parties. Investigators typically spend 5 to 8 hours
    examining each case.

    Supplemental Security Income	The payment accuracy rate is based on a
    detailed analysis of a sample of Supplemental Security Income cases.
    However, the Social Security Administration's Office of Inspector General
    reported that not all types of overpayments are counted as errors so
    payment accuracy rates do not correspond to overpayments reported in the
    Social Security Administration's financial statements.

    Social Security Disability Insurance 	The overpayment overclaim rate is
    based on a monthly sample selection from the payment rolls consisting of
    beneficiaries in current payment status. For each sampled case, the
    recipient or representative payee is interviewed, collateral contacts are
    made as needed, and all factors of eligibility are redeveloped as of the
    current sample month.

    School Lunch	The United States Department of Agriculture does not
    routinely collect data on the percentage of ineligible children receiving
    free or reduced price school lunches.

    Food Stamps	Under the food stamp quality control system, states draw a
    statistical sample, review case information, and make home visits to
    determine whether households were eligible for benefits and received the
    correct benefit payment. Regional offices validate the results by
    reviewing a subset of each state's overpayment and underpayment errors as
    necessary.

    Housing and Urban Development rental The overclaim rate is based on an
    in-depth analysis of a statistical sample of cases. The

    assistance programs	overclaim rate showed an increase in 2001 over
    previous years largely because Housing and Urban Development expanded its
    methodology for measuring error to cover three types of program errors -
    incorrect reporting of income by tenants; mistakes by public housing
    agencies, owners, and renting agents in calculating income and rent
    amounts; and mistakes made by public housing agencies, owners, and renting
    agents in completing appropriate paperwork and billing Housing and Urban
    Development for rental assistance.

    a

    Medicaid GAO has found that few states measure the overall accuracy of
    their payments.

    Medicare	This overclaim rate for Medicare fee-for-service claims is based
    on a review of claims conducted by the Housing and Human Service's
    Inspector General's office. The Inspector General used a multistage
    stratified sample design. For each claim, the provider was contacted and
    asked to provide copies of all medical records supporting services billed.
    These records were assessed to determine whether the services billed were
    reasonable, adequately documented, medically necessary, and coded in
    accordance with Medicare reimbursement rules and regulations. Billing
    practices were also reviewed. Starting in fiscal year 2003, the Centers
    for Medicare and Medicaid Services will publish a national overclaim rate
    developed through the Comprehensive Error Rate Testing Program and the
    Hospital Payment Monitoring Program. These programs build on the Inspector
    General's methodology.

    Temporary Assistance for Needy Families	Payment accuracy overclaim rates
    have not yet been calculated for the Temporary Assistance for Needy
    Families' program.

    Source: GAO analysis of multiple agency data.

    aU.S. General Accounting Office State, Efforts to Control Improper
    Payments Vary, GAO-01-662 (Washington, DC: June 7, 2001).

    Appendix III

                           Objectives, Scope, and Methodology

    Objectives	We were asked to respond to 12 questions about IRS's
    certification program, as shown in table 6.

                            Table 6: Questions We Were Asked

    1. 	What is the status of the EIC certification program, including the
    timing and number/types of taxpayers to be contacted?

    2. 	Has IRS "tested" or conducted a "focus-group" of any related letters,
    forms, or documents for understandability and other issues; and, if so,
    what have been the results of such efforts?

    3. 	(a) What is the appropriateness of the draft certification forms and
    explanations? (b) What are IRS's plans for processing them? (c) What types
    of documents will EIC taxpayers need to provide the IRS? (d) Will
    taxpayers generally be able to obtain the required documentation to
    otherwise establish eligibility within the required time frame, such as
    for marriage certificates, school transcripts, and rental agreements?

    4. 	What is the range of alternatives considered by IRS for obtaining
    similarly reliable documentation, including the cost of alternatives, and
    taking into account the cost of EIC noncompliance?

    5. 	What is the percentage of EIC claimants that would be required to
    precertify prior to the 2004 filing season?

    6. 	What information does IRS have regarding differences in the EIC
    overclaim rate among EIC claimants that are positively correlated with
    filing status, relationship to the qualifying child, or other factors?

    7. 	To what extent are the issues of concern in GAO's report on the
    current recertification program of similar concern in the new
    certification program, including probable solutions to problem areas?

    8. 	Does GAO believe the certification program has been adequately
    developed to prevent unreasonable burdens on EIC taxpayers and to improve
    compliance?

    9. What is the current process for evaluating EIC eligibility?

    10. 	(a) What is the current EIC error rate? (b) Have recent statutory
    changes had an impact on the error rate or on the rate of overpayments?
    (c) Were these statutory changes for the purpose of deterring
    noncompliance?

    11. 	What are the error rates of non-EIC taxpayer groups having
    significant compliance issues?

    12. 	What are the error rates of comparable benefit programs administered
    by states or the federal government and do these programs use any
    verification process?

    Source: Subcommittee on Oversight, House Committe on Ways and Means.

    In consultation with our requesters' offices, we grouped these questions
    into three objectives, as follows: (1) describe the design and basis for
    the EIC qualifying child certification program as proposed by the EIC task
    force, (2) describe the current status of the program, including
    significant changes since program approval, and (3) assess whether the
    program is

                                      Appendix III
                           Objectives, Scope, and Methodology

    adequately developed to (a) prevent unreasonable burdens on EIC taxpayers
    and (b) improve compliance so that the test should proceed. In addition,
    we were asked to provide readily available information on (1) significant
    noncompliance rates other than for the EIC and (2) the overclaim rates and
    administrative costs of comparable benefit programs administered by states
    or the federal government and any verification process used by these
    programs.

    Scope and Methodology

    To respond to all of the questions, we reviewed and analyzed relevant IRS
    and other documentation, such as compliance reports, EIC task force
    reports, draft letters and forms, testing and focus group records,
    implementation plans, evaluation plans, and our prior products, and
    interviewed Department of the Treasury and IRS officials involved in the
    EIC certification program, including the Assistant to the Commissioner;
    the National Taxpayer Advocate; Research, Analysis, and Statistics
    officials; and members of the qualifying child certification
    implementation team. We did not verify the accuracy of the data shown in
    the various reports that we reviewed. Rather, we reviewed the steps IRS
    had taken to implement the certification program and determined, to the
    extent possible, how IRS ensured that the program had been adequately
    developed to prevent unreasonable burden and improve compliance. We did
    not evaluate whether IRS's preparations for implementing the certification
    test, such as staffing and training, were sufficiently developed to
    support proceeding with the test, because they were outside the scope of
    our review, still under development, or the Treasury Inspector General for
    Tax Administration had audits planned.

    The first objective includes, in order, our response to questions 10, 4,
    and 6. To determine the current EIC error rates and whether any studies
    had been done on the impact of recent statutory changes on error rates, we
    reviewed IRS's most recent compliance study, the Treasury Inspector
    General for Tax Administration reports and our previous reports, and
    interviewed IRS officials. In addition, we reviewed the legislative
    history of recent statutory changes-effective since 1999-that pertained to
    EIC. We analyzed these data and IRS and Treasury reports to determine
    whether an analysis on the impact of the legislative changes on EIC error
    or overclaim rates had been conducted. To determine the range of
    alternatives considered by the task force, we reviewed documents and
    interviewed members of the EIC task force. To determine the correlation
    between overall EIC error rates, filing status, and gender, we interviewed
    officials from Research, Analysis, and

    Appendix III
    Objectives, Scope, and Methodology

    Statistics and analyzed their data, and reviewed the EIC task force
    reports and Treasury's past compliance studies.

    The second objective included, in order, our response to questions one,
    five, two, and seven. To determine the status of the EIC certification
    program, including the number and types of taxpayers to be contacted, we
    interviewed IRS and Treasury officials and reviewed documents showing
    timelines and key milestones. We reviewed plans for the certification
    program, such as IRS's Concept of Operations and the 2004 Increment
    Evaluation Plan, in conjunction with IRS's current process for evaluating
    EIC eligibility. To calculate the percentage of EIC claimants subject to
    certification in 2004, we divided the planned sample size by the number of
    EIC claimants with qualifying children. To obtain information on IRS's
    testing of letters, forms, and documents for understandability, we
    observed the focus group testing that IRS conducted in Dallas, Tex., with
    EIC taxpayers, tax preparers, and other parties to understand how IRS
    assured itself that such persons understood the forms and thought they
    could obtain the required documentation. For whether items of concern we
    found within the recertification program could have similar concerns in
    the new initiative, we analyzed our prior reports on IRS's recertification
    program and IRS's progress in implementing our recommendations, then we
    compared our analysis to the certification plans.

    The third objective includes, in order, our responses to questions eight
    and three. To make our determination as to whether the program had been
    adequately developed to improve compliance with minimal burden to
    taxpayers, we asked IRS officials to describe and provide documentation to
    support the steps they took to assure that the program was adequately
    developed. This included interviews and a high-level review of key steps
    and decisions found in various documents, such as the EIC task force
    reports, the Concept of Operations, staffing plans, training materials,
    and the evaluation plan. To determine the potential extent of the burden
    on taxpayers, we reviewed reports from outside groups that analyze
    programs and policies for low-income groups. We obtained the opinions of
    IRS officials and discussed those of outside stakeholders, such as
    representatives from the Annie E. Casey Foundation, low income taxpayer
    clinics, and large tax preparation organizations, that IRS had met with
    about any problems taxpayers might have in complying with the
    documentation requirements to establish EIC eligibility. We also
    interviewed IRS officials and reviewed EIC task force documents to learn
    about the range of alternatives taxpayers have available to obtain
    similarly

    Appendix III
    Objectives, Scope, and Methodology

    reliable documentation, if they were unable to comply with the
    certification documentation requirements.

    Our responses to questions 11 and 12 are in appendixes I and II,
    respectively. To determine the error rates of non-EIC taxpayer groups
    having significant compliance issues, we reviewed compliance research
    reports, interviewed officials about IRS's National Research Program, and
    reviewed information contained in the Strategy and Program Plan. We
    discussed our analysis with key IRS officials, including representatives
    of the Assistant to the Commissioner. To determine the overclaim rates,
    administrative costs, and verification process of comparable benefit
    programs administered by states or the federal government, we researched
    our prior reports and contacted our staff knowledgeable about the selected
    programs. We selected nine programs to review: Unemployment Insurance,
    Supplemental Security Income, Social Security Disability Insurance, school
    lunch, food stamps, Housing and Urban Development rental assistance,
    Medicaid and Medicare, and Temporary Assistance for Needy Families. We
    chose these programs largely because they were the same programs the EIC
    task force reviewed and because each of them had some sort of
    precertification program. We did not do a comprehensive analysis to
    determine which programs, if any, were most comparable to the EIC, nor did
    we determine whether the information reported for each program was
    consistent and could be compared across programs. We did not do additional
    analyses to determine how administrative costs compared to program
    outlays.

    Our response to question nine is in the background section of this report.
    To determine the current process for determining EIC eligibility, we
    reviewed relevant IRS documents and our prior reports. We verified the
    accuracy of this information in interviews with IRS officials.

    We conducted our work in Atlanta, Ga., Dallas, Tex., and Washington, D.C.,
    from May 2003 through September 2003 in accordance with generally accepted
    government auditing standards.

    Appendix IV

    Key Milestones for the Qualifying Child Certification Program

    Key milestones for the certification program for fiscal years 2002 through
    2005, are shown in figure 4.

    Figure 4: Key Milestones for the Certification Program

    2002

    2003

    2004

    2005

    Source: GAO analysis of IRS data.

    Appendix V

    Documents Related to the Precertification Program

    According to agency officials, IRS will send each of the 25,000 taxpayers
    subject to precertification four documents, including (1) Notice 84-A, a
    letter informing taxpayers about the new program; (2) Form 8836,
    "Qualifying Children Residency Statement;" (3) Publication 3211M, "Earned
    Income Tax Credit Question and Answers;" and (4) Publication 4134,
    "Free/Nominal Cost Assistance Available for Low Income Taxpayers." Copies
    of these documents, current as of September 2003, follow.

    Appendix V
    Documents Related to the Precertification
    Program

    Appendix V
    Documents Related to the Precertification
    Program

    Appendix V
    Documents Related to the Precertification
    Program

    Appendix V
    Documents Related to the Precertification
    Program

    Appendix V
    Documents Related to the Precertification
    Program

    Appendix V
    Documents Related to the Precertification
    Program

    Appendix V
    Documents Related to the Precertification
    Program

    Appendix V
    Documents Related to the Precertification
    Program

    Appendix V
    Documents Related to the Precertification
    Program

                                      Appendix VI

                       Comments from the Internal Revenue Service

    Appendix VI
    Comments from the Internal Revenue Service

    Appendix VI
    Comments from the Internal Revenue Service

    Appendix VI
    Comments from the Internal Revenue Service

    Appendix VI
    Comments from the Internal Revenue Service

    Appendix VI
    Comments from the Internal Revenue Service

    Appendix VII

                         GAO Contacts and Staff Acknowledgments

    GAO Contacts	Michael Brostek (202) 512-9110 Joanna Stamatiades (404)
    679-1984

    Acknowledgments	In addition to those named above, Tiffany Brown, Evan
    Gilman, Veronica Mayhand, Kathryn Larin, David Lewis, Donna Miller, Libby
    Mixon, Cheryl Peterson, and Tom Short made key contributions to this
    report.

    GAO's Mission	The General Accounting Office, the audit, evaluation and
    investigative arm of Congress, exists to support Congress in meeting its
    constitutional responsibilities and to help improve the performance and
    accountability of the federal government for the American people. GAO
    examines the use of public funds; evaluates federal programs and policies;
    and provides analyses, recommendations, and other assistance to help
    Congress make informed oversight, policy, and funding decisions. GAO's
    commitment to good government is reflected in its core values of
    accountability, integrity, and reliability.

    Obtaining Copies of GAO Reports and Testimony

    The fastest and easiest way to obtain copies of GAO documents at no cost
    is through the Internet. GAO's Web site (www.gao.gov) contains abstracts
    and full-text files of current reports and testimony and an expanding
    archive of older products. The Web site features a search engine to help
    you locate documents using key words and phrases. You can print these
    documents in their entirety, including charts and other graphics.

    Each day, GAO issues a list of newly released reports, testimony, and
    correspondence. GAO posts this list, known as "Today's Reports," on its
    Web site daily. The list contains links to the full-text document files.
    To have GAO e-mail this list to you every afternoon, go to www.gao.gov and
    select "Subscribe to e-mail alerts" under the "Order GAO Products"
    heading.

    Order by Mail or Phone	The first copy of each printed report is free.
    Additional copies are $2 each. A check or money order should be made out
    to the Superintendent of Documents. GAO also accepts VISA and Mastercard.
    Orders for 100 or more copies mailed to a single address are discounted 25
    percent. Orders should be sent to:

    U.S. General Accounting Office 441 G Street NW, Room LM Washington, D.C.
    20548

    To order by Phone: 	Voice: (202) 512-6000 TDD: (202) 512-2537 Fax: (202)
    512-6061

    To Report Fraud, 	Contact: Web site: www.gao.gov/fraudnet/fraudnet.htm

    Waste, and Abuse in E-mail: fraudnet@gao.gov

    Federal Programs Automated answering system: (800) 424-5454 or (202)
    512-7470

    Public Affairs	Jeff Nelligan, Managing Director, NelliganJ@gao.gov (202)
    512-4800 U.S. General Accounting Office, 441 G Street NW, Room 7149
    Washington, D.C. 20548

                                   Presorted Standard
                                  Postage & Fees Paid
                                          GAO
                                    Permit No. GI00

    United States
    General Accounting Office
    Washington, D.C. 20548-0001

    Official Business
    Penalty for Private Use $300

    Address Service Requested
    *** End of document. ***