Adoption Tax Credit:

IRS Can Reduce Audits and Refund Delays

GAO-12-98: Published: Oct 20, 2011. Publicly Released: Nov 21, 2011.

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The federal adoption tax credit, established in 1996, was amended in 2010. These amendments included making the credit refundable (meaning taxpayers could receive payments in excess of their tax liability) and increasing the maximum allowable credit to $13,170 of qualified adoption expenses for tax year 2010. As of August 20, 2011, taxpayers filed just under 100,000 returns, claiming about $1.2 billion in adoption credits. Following these changes, the Internal Revenue Service (IRS) developed a strategy for processing adoption credit claims. GAO was asked to (1) describe IRS's strategy for ensuring compliance with the adoption credit for the 2011 filing season, (2) assess IRS's related communication with taxpayers and stakeholders, and (3) assess its processing and audit of claims. To conduct its analysis, GAO analyzed IRS data and documents, interviewed IRS officials, observed IRS examiners, and interviewed other stakeholders.

IRS's strategy for ensuring taxpayer compliance with the adoption credit included the following: (1) Communicating and reaching out to taxpayers and other stakeholders, including tax professionals and adoption organizations, about new requirements. (2) Requiring taxpayers seeking the adoption credit to submit proof of a completed or in-progress adoption with their return. Because taxpayers claiming the credit for a special needs child (meaning that a state determined the child cannot or should not be returned to a parent, and using specified criteria, the state can reasonably assume that the child will not be adopted without state assistance) are allowed to claim the full credit without providing documentation of adoption expenses, they also needed to provide documentation certifying the special needs status of the child. (3) Requiring that returns and supporting documentation be filed on paper. (4) Automatically sending returns with missing or invalid documentation for correspondence audits (audits that IRS conducts by mail). To inform taxpayers, paid preparers and other stakeholders about new adoption credit requirements, IRS used various tools including its website, Twitter accounts, and YouTube recordings. However, IRS did not make a specific effort to communicate or convey information about documentation requirements for special needs children to state adoption managers, who administer state adoption programs. Further, IRS did not specify in training materials for its audit examiners what documentation was required to prove special needs status. IRS later revised its training materials to say that a state adoption assistance agreement (an agreement between the state and adoptive parents) was sufficient proof but did not provide samples of such agreements in the materials or place any on its website. As a consequence, taxpayers submitted a majority of returns with either no documentation or insufficient documentation. As of August 2011, 68 percent of the nearly 100,000 returns on which taxpayers claimed the adoption credit were sent to correspondence audit. However, of the approximately 35,000 returns on which audits have been completed as of August, IRS only assessed additional tax about 17 percent of the time. The equivalent rate for all correspondence audits in 2010 was 86 percent. The time it has taken IRS to audit these predominantly legitimate adoption credit claims has resulted in considerable delays in the payment of the related refunds. For the 2012 filing season, IRS has options that might allow it to reduce the number of costly audits and issue refunds faster while still maintaining a robust enforcement strategy. One option is for IRS to immediately send a letter to taxpayers who submit returns without any documentation requesting it before initiating an audit. This could potentially reduce the number of audits and delayed refunds, but IRS has not yet determined the extent of this impact. IRS officials acknowledged that data from the 2011 filing season experience should allow them to determine whether sending an initial letter requesting documentation would be more effective than initiating a correspondence audit. GAO recommends that IRS communicate with state and local adoption officials, provide examiners with examples of adoption assistance agreements, place the agreements on its website, and determine whether sending a letter before initiating an audit would reduce the need for audits. IRS generally agreed with three of GAO's recommendations, but had concerns that placing sample agreements on its website may enable fraud. However, since other proof of adoption must accompany a tax credit claim, GAO believes the benefits of making these agreements available to adoptive parents outweigh the risks.

Status Legend:

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  • Review Pending-GAO has not yet assessed implementation status.
  • Open-Actions to satisfy the intent of the recommendation have not been taken or are being planned, or actions that partially satisfy the intent of the recommendation have been taken.
  • Closed-implemented-Actions that satisfy the intent of the recommendation have been taken.
  • Closed-not implemented-While the intent of the recommendation has not been satisfied, time or circumstances have rendered the recommendation invalid.
    • Review Pending
    • Open
    • Closed - implemented
    • Closed - not implemented

    Recommendations for Executive Action

    Recommendation: For the 2012 filing season, the Commissioner of Internal Revenue should instruct appropriate officials to place the agreements on its website to help taxpayers better understand what constitutes acceptable documentation.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Not Implemented

    Comments: In IRS's statutorily-required response to our report, IRS said that while posting examples of assistance agreements on its website might be helpful for taxpayers, doing so might also enable unscrupulous individuals to create fictitious documents and submit fraudulent claims. In February 2013, IRS confirmed that this continues to be its policy.

    Recommendation: For the 2012 filing season, the Commissioner of Internal Revenue should instruct appropriate officials to provide examples of adoption assistance agreements that meet the requirements for documenting special needs status, from each state and the District of Columbia, in training materials given to reviewers and examiners.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: In accordance with our recommendation, IRS initially placed 24 examples of state adoption agreements on an internal website for the use of IRS examiners and reviewers and by the 2013 filing season. IRS continued to add examples during the 2012 season and had 45 examples available. This led to IRS examiners being better prepared to evaluate claims for credits for adopted children with special needs.

    Recommendation: For the 2012 filing season, the Commissioner of Internal Revenue should instruct appropriate officials to ensure that the communications effort specifically includes state and local adoption officials, and clarifies acceptable documentation for the certification of special needs adoptees.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: In its response to our report, IRS agreed with the recommendation, and plans, as part of its adoption communications strategy to undertake targeted outreach to state adoption officials and adoption organization representatives, highlighting adoption documentation requirements, and including specific messages for documentation of special needs status. In response to our recommendation, for the 2012 filing season, IRS reported that it took several actions including revising instructions to Form 8839, Qualified Adoption, and updating its website, irs.gov, to add information about 2012 for adoptive parents. In addition, for the 2013 filing season, IRS reported taking more actions including issuing email alert to adoption advocacy and public policy organizations; issuing IRS Tax Tip 2013-54, Ten Facts about Adoption-Related Tax Savings and presenting GAO's findings to members of the IRS/EITC Software Developers Working Group which includes software industry representatives. IRS's efforts led to increased awareness on the part of stakeholders and taxpayers dealing with the adoption tax credit for the 2012 and 2013 filing seasons.

    Recommendation: For the 2012 filing season, the Commissioner of Internal Revenue should instruct appropriate officials to determine whether requesting documentation in cases where no documentation is provided before initiating an audit would reduce the number of audits without significantly delaying refunds and, if so, implement such a strategy for the 2012 filing season.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: In IRS's statutorily-required response to our report, IRS said that it had done a comprehensive review of its compliance strategy at the end of the 2011 filing season. IRS provided a summary of the review and its conclusions. IRS concluded that, with the greatly reduced number of claims it expected during the 2012 filing season, the enhanced outreach and education efforts it planned to make and the changes to the credit claim form, and the fact that the 2012 filing season will be the last with a refundable credit, the best course of action was to continue sending returns with missing or inadequate documentation directly to Examination after initial receipt.

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