IRS Targets Tax Returns of Those Adopting a Child for Audits

You can add one more item to the list of flags that have led the IRS to mishandle the audits of tax returns: choosing to adopt a child.

A report released by the Taxpayer Advocate Service found that the IRS performed for the 2012 tax year an additional review of 90 percent of tax returns where the families had adopted a child.  In addition, approximately 70 of families who adopted a child were subject to an IRS audit.

For 2012, only approximately one percent of all tax returns were subject to audit.

The report noted that “The IRS’s misguided procedures, and its failure to adequately adjust these processes when it learned its approach was seriously flawed, have caused significant economic harm to thousands of families who are selflessly trying to improve the lives of vulnerable children.”

The report found that in general tax returns claiming one or more credits, such as the Adoption Tax Credit, were audited at a higher rate than the general population.  Those claiming the Adoption Tax Credit were audited at a particularly high rate.

The report noted that although approximately 70 percent of tax returns claiming the Adoption Tax Credit were audited, the amount of additional tax revenue collected as a result of the audits was relatively small.

“Of the $668.1 million in adoption credit claims in tax year 2011 as a result of adoption credit audits, the IRS only disallowed $11 million — or one and one-half percent — in adoption credit claims.  However, the IRS has also had to pay out $2.1 million in interest in [tax year] 2011 to taxpayers whose refunds were held past the 45-day period allowed by law.”

The report noted that the inefficient use of taxpayer dollars in terms of generating additional tax revenue or minimize expenses of the IRS will continue until the IRS adjusts its criteria for selecting returns for audits to target tax returns more likely to yield a substantial payback amount.

A spokesperson with the IRS defended the audit policy for the Adoptive Tax Credit despite data pointing to its ineffectiveness.

“The IRS implemented the adoption credit program with an approach that balanced the objective of paying legitimate credits in a timely manner with that of ensuring that claims were accurate,” noted Michelle Eldridge with the IRS.  “Our experiences and lessons learned from other refundable credits taught us that high dollar credits have high risk and the potential for fraud.  We must ensure delivery of the credit to those entitled while protecting the government’s interest in minimizing exposure to fraud.”

The report recommended that the IRS provide additional guidance on the proper documentation taxpayers should include when requesting the Adoption Tax Credit, improve options for proving when a child has a special need, and improving guidelines for filing electronic returns with the Adoption Tax Credit.

“The IRS, facing a sizeable refundable credit, reacted with an enforcement strategy that was focused on stopping nearly all returns claiming the credit and subjecting a large percentage of them to an audit, instead of reaching out to stakeholders (including states) to understand the impacted taxpayer population,” the report continued.  “When problems emerged, the IRS simply continued selecting returns for audit.  This approach forced taxpayers to withstand lengthy delays and the IRS to expend valuable resources with very little to show for them.”

by Mark Johnston

Mark has been a contributor to legal web sites related to bankruptcy, tax, and criminal law since 2011. He has an Accounting degree from Texas A&M University.