IRS Faulted On Poor Tax Return Data ManagementIRS Faulted On Poor Tax Return Data Management

Better use and management of third-party data could save the Internal Revenue Service (IRS) more than $1 billion in potentially erroneous tax refunds, according to a government audit.

The IRS is not "fully using the third-party data it receives during returns processing," which is resulting in the agency making refunds and credits that "are not allowable by law," according to a heavily redacted report by the Treasury's inspector general for tax administration.

"We identified a number of areas in which the IRS could make more effective use of third-party data to identify and stop erroneous and improper claims for credits and refunds," according to the report.

The inspector general also found that the IRS must better identify and control all the data it receives from third parties, according to the report. Currently, the agency has no central control point for third-party data.

Examples of third-party data include income information from employers, government agencies, and financial institutions. The IRS uses this data to determine if the tax credits or refunds U.S. taxpayers say they are eligible for in their income tax returns are valid.

One area where the IRS especially could use third-party data is ensuring the validity of tax credits, in particular the earned income tax credit (EITC), according to the report.

The audit makes several recommendations to the IRS to remedy the situation, including a call for "clarifying" legislation to address the issue.

Until that happens, the inspector general recommended that the IRS freeze refunds and contact taxpayers with potentially invalid EITC claims or questionable information on their tax returns, and require valid responses from taxpayers before allowing them to claim the EITC. The IRS also should adjust the amount of refunds if it doesn't receive a timely response about questionable EITC claims.

The IRS, however, disagreed with recommendations to freeze or adjust refunds, claiming that the agency's "existing authority" to address the issue can only be exercised through an examination of a tax return, a strategy it already has in place.

"Management does not believe that refocusing other resources on this issue will meet the IRS goal of a balanced compliance program that strategically addresses noncompliance with the resources available," according to the report.