The Earned Income Tax Credit (EITC) is a refundable tax credit that provides financial support to millions of taxpayers. However, the EITC rules are complicated. EITC audits can be time-consuming and may involve disclosing personal family situations, which taxpayers may find uncomfortable. In fiscal year (FY) 2022, the IRS closed nearly 260,000 EITC audits. Of these audits, nearly 18 percent were closed as “no change.” Almost 38 percent were closed as “no response from the taxpayers,” and 25 percent were closed as “taxpayer default,” meaning the taxpayer participated in the audit but the IRS ultimately adjusted their returns because they neither agreed with the IRS’s audit determination nor expressed disagreement by exercising their right to seek an administrative appeal or petition the U.S. Tax Court. Only 1,223 taxpayers petitioned the U.S. Tax Court.
Similar to the findings discussed in my 2021 Annual Report to Congress, 55 percent of the returns that claimed EITC and were selected for audit in FY 2022 were prepared by tax professionals; however, only three percent of these taxpayers had professional representation during the EITC audit process. It isn’t surprising that taxpayers requiring assistance claiming the EITC would also require assistance when later substantiating the credit during an IRS audit. Unfortunately, many of these returns are prepared by unenrolled return preparers who cannot represent taxpayers before the IRS. Most of these taxpayers must rely solely on an IRS toll-free audit assistance telephone line – a line where only 44 percent of callers between October 1, 2022, and July 22, 2023, reached live assistance. Corresponding with the IRS about an EITC audit also has its challenges. As I discussed in my 2022 Annual Report to Congress, the IRS has been plagued with correspondence backlogs. For FY 2022, the weekly average of overaged audit correspondence received by Wage and Investment (W&I) was 66 percent, with a weekly overage average of 57 percent through July of FY 2023. These delayed IRS responses often leave taxpayers to wonder if the IRS received their documentation, if their correspondence was sufficient, and when they may receive a refund or response. And as I discussed in my 2020 Annual Report to Congress, I think that is a real problem.
I suspect that the high percentage of no response and defaulted EITC audit cases may be due, at least in part, to compliance challenges rather than credit ineligibility. Some of these challenges include understanding IRS audit notices, gathering and providing the appropriate supporting documentation, responding to audit requests within stated deadlines, and the inability to work with an assigned employee who could educate and assist during the audit process – interaction I believe would lead to increased audit participation and perhaps increased future compliance.
The IRS has posted information and developed tools to assist taxpayers undergoing an audit, to include specific EITC-related guidance intended to facilitate accurate audit responses. These tools are beneficial, especially when the IRS is difficult to reach by phone and slow to respond by correspondence. Taxpayers experiencing an EITC audit will generally receive a Notice CP 75 or 75A, explaining that the EITC portion of their refund is being held pending the receipt of requested documentation necessary to verify EITC eligibility.
EITC audits often occur because IRS records show that a child claimed by the taxpayer does not meet the relationship or residency test to be considered a qualifying child under IRC § 32(c)(3). EITC audits may also occur when the income shown on a return does not match the income reported to the IRS by third parties or does not meet the earned income requirements of IRC § 32(c)(2). Often taxpayers claiming EITC based on self-employment income will be asked to provide copies of business records to substantiate claimed income and deductions. There are many online resources that taxpayers may find helpful, several of which are listed below:
Failing to respond will usually result in an IRS determination to disallow the EITC in question, and ultimately an IRS adjustment to the taxpayer’s tax return. It is important that taxpayers respond timely and provide the requested documentation. If the taxpayer is unable to gather the documentation before the deadline they should call or write to the IRS and ask for more time. Ignoring the IRS is not a good strategy. Taxpayers who cannot provide the specific documentation requested but believe they are entitled to the EITC claimed should provide any alternative documentation available for consideration, including written statements. TAS assembled a list of “alternative” documents that can be submitted for consideration and developed case scenarios to illustrate how various documentation can be used to support EITC eligibility. Examples are also provided to assist self-employed taxpayers needing assistance identifying documentation to substantiate the income they earned. If the IRS disagrees with the taxpayer’s position, they have a right to request a review by the IRS Independent Office of Appeals and they can file a petition in the U.S. Tax Court to have the matter heard by an independent judge.
I understand the EITC rules can be complicated. For this reason, TAS continues to advocate for legislation that would restructure the EITC to make it simpler for taxpayers. Despite the challenges involved, I encourage all taxpayers undergoing an EITC audit to fully participate in the EITC audit process and work with the IRS by supplying any available documentation to support EITC eligibility. Qualifying taxpayers needing assistance with an EITC audit may obtain free representation by contacting a Low Income Taxpayer Clinic, while qualifying taxpayers facing a hardship due to an EITC audit may contact the Taxpayer Advocate Service for assistance.
LITCs are independent from the IRS and TAS. LITCs represent individuals whose income is below a certain level and who need to resolve tax problems with the IRS. LITCs can represent taxpayers in audits, appeals, and tax collection disputes before the IRS and in court, including the Tax Court. In addition, LITCs can provide information about taxpayer rights and responsibilities in different languages for individuals who speak English as a second language. For more information or to find an LITC near you, see IRS Publication 4134, Low Income Taxpayer Clinic List or visit www.taxpayeradvocate.irs.gov/litc.
The views expressed in this blog are solely those of the National Taxpayer Advocate. The National Taxpayer Advocate presents an independent taxpayer perspective that does not necessarily reflect the position of the IRS, the Treasury Department, or the Office of Management and Budget.