The IRS has been too vociferous in auditing individuals who have claimed the adoption tax credit, the Government Accountability Office (GAO) suggests in a report.
In “Adoption Tax Credit: IRS Can Reduce Audits and Refund Delays,” the GAO reports that the IRS: (1) did not sufficiently train and communicate with its auditors who were examining returns on which the credit was claimed; (2) audited too many taxpayers who claimed the credit; and (3) conducted many audits that were fruitless and did not result in collection of additional revenue. The cure, the GAO says, is for the IRS to better communicate, better prepare examiners and consider ways to reduce the need for audits.
The GAO conducted the study at the request of Senate Finance Committee Chairman Max Baucus (D-Mont.) and House Subcommittee on Oversight Committee on Ways and Means Chairman Rep. Charles W. Boustany, Jr. (R-La.).
The GAO report says that while the IRS used a variety of means to inform taxpayers, paid preparers and others involved in applying the new adoption credit requirements, it did not inform state adoption managers, who administer state adoption programs, about documentation requirements for adoptions of special-needs children. Further, the IRS did not specify in training materials for its audit examiners what documentation was required to prove special-needs status.
The 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. However, the IRS did not provide examples of such agreements in the training materials or place any on its website.
The result: Taxpayers submitted a majority of returns with either no documentation or insufficient documentation.
By August 2011, the IRS was auditing 68 percent of the nearly 100,000 returns on which taxpayers claimed the adoption credit. However, of the approximately 35,000 returns on which audits were completed, the IRS assessed additional tax only about 17 percent of the time.
Not only have these audits failed to result in additional revenue, says the GAO, the time the IRS spent conducting those audits delayed payment of refunds due those who were audited.
GAO Recommendations
The GAO suggested that the IRS take the following steps to reduce the number of audits and issue refunds faster while still vigorously enforcing the rules.
- Before it initiates an audit, send letters requesting documentation to taxpayers that submit returns without it. This could reduce the number of audits and delayed refunds, but IRS has not yet determined the extent of this impact.
- Communicate with state and local adoption officials, provide examiners with examples of adoption assistance agreements and place the agreements on its website.
- Clarify acceptable documentation for the certification of special-needs adoptees.
The GAO said that the IRS has expressed concern that placing sample agreements on its website could make fraud possible. The GAO does not share this concern, however, because other forms of proof of adoption must accompany tax credit claims. And whatever the risks of making these agreements available to adoptive parents may be, the GAO believes that the benefits of doing so outweigh the risks it entails.
Adoption assistance programs provided as part of an employer’s benefits package, and the tax implications of such programs, are discussed the Employer’s Handbook: Complying with IRS Employee Benefits Rules.