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United States Government Accountability Office: 
GAO: 

Report to Congressional Requesters: 

October 2011: 

Adoption Tax Credit: 

IRS Can Reduce Audits and Refund Delays: 

GAO-12-98: 

GAO Highlights: 

Highlights of GAO-12-98, a report to congressional requesters. 

Why GAO Did This Study: 

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 IRSs strategy for ensuring 
compliance with the adoption credit for the 2011 filing season, (2) 
assess IRSs 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. 

What GAO Found: 

IRSs strategy for ensuring taxpayer compliance with the adoption 
credit included the following: 

* Communicating and reaching out to taxpayers and other stakeholders, 
including tax professionals and adoption organizations, about new 
requirements. 

* 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. 

* Requiring that returns and supporting documentation be filed on 
paper. 

* 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. 

What GAO Recommends: 

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 GAOs 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. 

View [hyperlink, http://www.gao.gov/products/GAO-12-98] or key 
components. For more information, contact James R. White at (202) 512-
9110 or whitej@gao.gov. 

[End of section] 

Contents: 

Letter: 

Background: 

IRS's Adoption Tax Credit Compliance Strategy Involved Communication, 
Documentation, and Audit: 

Taxpayers and Stakeholders Did Not Have Important Information on the 
Adoption Tax Credit: 

IRS Can Reduce the Number of Audits in 2012: 

Conclusions: 

Recommendations for Executive Action: 

Agency Comments and Our Evaluation: 

Appendix I: Adoption Tax Credit Provisions, 1996 to the Present: 

Appendix II: Comments from the Internal Revenue Service: 

Appendix III: GAO Contact and Staff Acknowledgments: 

Tables: 

Table 1: IRS Options for the 2012 Filing Season: 

Table 2: Adoption Tax Credit Provisions, 1996 to the Present: 

Figures: 

Figure 1: Number and Dollar Amount of Adoption Tax Credit Claims, Tax 
Years 1998-2010: 

Figure 2: Screening of Returns on Which Taxpayers Claim the Adoption 
Tax Credit: 

Abbreviations: 

CPI: Consumer Price Index: 

FTHBC: First-Time Homebuyer Credit: 

HHS: Department of Health and Human Services: 

IRS: Internal Revenue Service: 

MEA: math error authority: 

PPACA: Patient Protection and Affordable Care Act: 

TIGTA: Treasury Inspector General for Tax Administration: 

[End of section] 

United States Government Accountability Office: 
Washington, DC 20548: 

October 20, 2011: 

The Honorable Max Baucus: 
Chairman: 
Committee on Finance: 
United States Senate: 

The Honorable Charles W. Boustany, Jr. 
Chairman: 
The Honorable John Lewis: 
Ranking Member: 
Subcommittee on Oversight: 
Committee on Ways and Means: 
House of Representatives: 

As an incentive to encourage adoptions, since 1996 taxpayers have been 
able to take a tax credit for adoption-related expenses. In 2010, 
Congress expanded the adoption tax credit from $10,000 to a maximum of 
$13,170 and made the credit refundable for tax years 2010 and 2011, 
meaning taxpayers could receive payments even if their tax liability 
was less than the credit. Because of the changes, the Internal Revenue 
Service (IRS) developed a new enforcement strategy that included 
communication with taxpayers and stakeholders to ensure that they 
understood the new law and related documentation requirements. The 
strategy also included special screening of adoption credit claims 
followed by audit if the documentation was missing or looked 
questionable. 

In this context, you asked us to: 

* describe IRS's strategy for ensuring taxpayer compliance with the 
adoption tax credit, 

* assess IRS's adoption tax credit-related communication with 
taxpayers and stakeholders, and: 

* assess IRS's processing and audit of adoption tax credit claims and 
identify improvements, if needed, for the 2012 filing season. 

For this report, we analyzed IRS information on adoption credit claims 
for tax year 2010 and prior years and audit work conducted during the 
2011 filing season.[Footnote 1] We obtained and reviewed IRS plans for 
processing and auditing returns on which taxpayers claimed the credit 
and for communicating information about the credit to the public, tax 
professionals, and other stakeholders. We used IRS's adoption credit 
communication and compliance strategies as criteria for assessing 
IRS's performance. We interviewed IRS officials, including examiners, 
responsible for processing and auditing adoption credit claims and for 
communication. We also interviewed key outside stakeholders, including 
Treasury Inspector General for Tax Administration (TIGTA) officials 
and representatives of adoption advocacy organizations, such as the 
Child Welfare League of America and the North American Council for 
Adoptable Children. We spoke to adoption officials in five states 
recommended to us by the advocacy organizations to examine how states 
were dealing with the adoption tax credit. We spoke with IRS officials 
and reviewed data collection procedures and determined the data used 
in this report were sufficiently reliable for our purposes. 

We conducted this performance audit from December 2010 through October 
2011 in accordance with generally accepted government auditing 
standards. Those standards require that we plan and perform the audit 
to obtain sufficient, appropriate evidence to provide a reasonable 
basis for our findings and conclusions based on our audit objectives. 
We believe that the evidence obtained provides a reasonable basis for 
our findings and conclusions based on our audit objectives. 

Background: 

The federal adoption tax credit was first authorized in the Small 
Business and Job Protection Act of 1996, which provided for a 
nonrefundable credit for adoption expenses, not to exceed $5,000, or 
$6,000 for children with special needs.[Footnote 2] Special needs 
children are defined as those children who a state determined 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. Parents of adoptive children with special 
needs are also eligible for direct assistance under Title IV-E of the 
Social Security Act. 

Although the federal Department of Health and Human Services (HHS) 
oversees state administration of the payments for direct adoption 
assistance, the state agencies designate which children are considered 
to have special needs. State adoption agency managers provide guidance 
to adoptive families on how to manage the adoption process and 
frequently receive inquiries about documentation and other 
administrative requirements. Documentation certifying adoptions varies 
from state to state. In its oversight role for state adoption 
programs, HHS provides information to states through guidance and 
technical assistance. It also provides information to states and 
families on adoption-related issues through websites. 

When the credit was first enacted in 1996, families that had 
qualifying expenses greater than the maximum limit for the credit 
could carry over that amount and claim those expenses for up to 5 
years.[Footnote 3] Also, the law phased out the credit for taxpayers 
above an upper income limit (which was $182,520 in adjusted gross 
income for tax year 2010). Families adopting non-special needs 
children can claim only the amount of documented qualified expenses up 
to the maximum limit. However, since 2002, families adopting special 
needs children have been able to claim the maximum tax credit without 
having to document adoption expenses. 

For tax years 2010 and 2011, the Patient Protection and Affordable 
Care Act (PPACA) of 2010 made the adoption credit refundable and set 
the maximum credit at $13,170 for 2010, with the maximum amount for 
2011 indexed for inflation.[Footnote 4] The credit is scheduled to 
revert to a nonrefundable credit with a $10,000 maximum for tax year 
2012. For 2013 and beyond, the credit will be available only for 
special needs adoptions and may only be claimed for qualified expenses 
incurred up to a maximum of $6,000.[Footnote 5] See appendix I for 
detailed information on adoption tax credit legislation. 

Since the original provision was adopted in 1996, taxpayers have 
claimed about $4.28 billion in adoption tax credits. For tax year 
2010, taxpayers filed almost 100,000 returns claiming the credit, with 
over $1.2 billion claimed as of August 2011. Figure 1 shows the total 
number of claimants and amount of claims for each year since 1998. 
[Footnote 6] 

Figure 1: Number and Dollar Amount of Adoption Tax Credit Claims, Tax 
Years 1998-2010: 

[Refer to PDF for image: multiple line graph] 

Year: 1998; 
Number of returns: 40,668; 
Amount claimed: $83.05 million. 

Year: 1999; 
Number of returns: 47,349; 
Amount claimed: $103.02 million. 

Year: 2000; 
Number of returns: 42,681; 
Amount claimed: $91.87 million. 

Year: 2001; 
Number of returns: 47,737; 
Amount claimed: $88.78 million. 

Year: 2002; 
Number of returns: 55,905; 
Amount claimed: $234.11 million. 

Year: 2003; 
Number of returns: 63,980; 
Amount claimed: $349.79 million. 

Year: 2004; 
Number of returns: 71,136; 
Amount claimed: $301.89 million. 

Year: 2005; 
Number of returns: 84,793; 
Amount claimed: $319.56 million. 

Year: 2006; 
Number of returns: 93,369; 
Amount claimed: $351.18 million. 

Year: 2007; 
Number of returns: 94,128; 
Amount claimed: $396.04 million. 

Year: 2008; 
Number of returns: 88,628; 
Amount claimed: $353.49 million. 

Year: 2009; 
Number of returns: 82,014; 
Amount claimed: $412.53 million. 

Year: 2010; 
Number of returns: 99,980; 
Amount claimed: $1.195 billion. 

Source: GAO analysis of IRS data. 

[End of figure] 

We have previously reported that refundable tax credits have presented 
a challenge to IRS. Because taxpayers can claim refundable credits in 
excess of their tax liability, those attempting to commit fraud may 
file false claims in efforts to get improper payments from the 
Treasury. For example, IRS has had to deal with fraudulent claims and 
improper payments involving the Earned Income Tax Credit and First-
Time Homebuyer Credit (FTHBC), both of which are refundable.[Footnote 
7] In such cases, Congress and IRS have taken steps to reduce the 
amount of fraud and improper payments while trying to minimize the 
number of returns that need to be audited. Audits are reviews of 
taxpayers' records to determine if they paid the correct amount of 
taxes. 

As we have also previously reported, audits are costly to IRS and can 
create delays in delivering refunds to taxpayers because, in some 
cases, IRS holds the portion of the refund being audited until the 
audit is complete.[Footnote 8] As an alternative to the standard audit 
process, Congress can approve math error authority (MEA) to allow IRS 
to automatically deny claims, without doing an audit, in cases where 
the taxpayer did not provide required documentation. In 2009, Congress 
approved MEA for the FTHBC, which helped significantly reduce improper 
payments. Having MEA allows IRS to automatically deny credit claims in 
instances where IRS can tell with virtual certainty that the taxpayer 
did not provide all of the required information and allows IRS to 
devote costly audit resources to other priorities.[Footnote 9] In 
cases where taxpayers disagree with the credit disallowance, they may 
request an abatement. 

IRS's Adoption Tax Credit Compliance Strategy Involved Communication, 
Documentation, and Audit: 

After the changes to the adoption tax credit took effect in 2010, IRS 
adopted a compliance strategy to minimize improper payments and 
maximize accurate returns. This strategy included the following major 
elements: 

* Communicating and reaching out to taxpayers, tax professionals, 
Congress, the states, and adoption organizations, with the objective 
of conveying information about changes in the law and documentation 
requirements. 

* Requiring taxpayers claiming the credit to submit documentation that 
the adoption of the child for whom credit was being claimed was 
already completed or in progress (an adoption order or decree for a 
completed adoption, or a home study, placement agreement, hospital or 
court document, or lawyer's affidavit for an adoption in progress), 
along with IRS Form 8839. 

* Requiring taxpayers claiming special needs status for their child to 
submit documentation from their state or local adoption authority 
certifying that status. 

* Requiring taxpayers claiming the credit to file on paper rather than 
electronically so that required documentation could be included with 
the return. 

* Screening returns for proper documentation and possible audit, as 
shown in figure 2. 

Figure 2: Screening of Returns on Which Taxpayers Claim the Adoption 
Tax Credit: 

[Refer to PDF for image: illustration] 

Taxpayer submits return claiming adoption tax credit: 

IRS examiner screens return for valid documentation: 
* If valid documentation found, IRS processes return; 
* If documentation is missing or examiners cannot determine its 
validity, IRS sends the return to correspondence audit (an audit by 
mail). IRS releases the portion of any refund due that is unrelated to 
the adoption credit or any other issue being audited: 
- If IRS determines the adoption credit claim is not valid, IRS denies 
the credit; 
- If IRS determines the adoption credit claim is valid, IRS awards the 
credit. 

Source: GAO. 

[End of figure] 

IRS's strategy included monitoring the success of its efforts in 
processing tax year 2010 adoption credit claims during the 2011 filing 
season. IRS officials met in early October 2011 to discuss lessons 
learned concerning the execution of its tax year 2011 adoption credit 
strategy and consider changes in the strategy for next year's filing 
season. 

Taxpayers and Stakeholders Did Not Have Important Information on the 
Adoption Tax Credit: 

To inform taxpayers, paid preparers, state agencies, adoption advocacy 
groups, and other stakeholders about the new law and documentation 
requirements, IRS planned to use various means of communication, such 
as its website, media releases, phone forums, webinars, Twitter 
accounts, and YouTube recordings. IRS aimed its communications at 
interested parties, such as paid tax preparers and adoption advocates 
and agencies, through, for example, specially directed e-mails, 
articles in professional publications, and appearances at meetings and 
conferences. 

However, IRS missed some opportunities to communicate on matters that 
later became areas of concern. For example, while IRS held a webinar 
on the adoption tax credit for tax professionals, IRS officials 
reported that because of a lack of resources they canceled the single 
scheduled webinar for adoption agencies and organizations that may 
have clarified IRS's documentation requirements for claiming the 
adoption credit. In addition, IRS did not make an effort to 
communicate to state adoption program managers or convey information 
about documentation requirements for claims involving special needs 
children, which could have helped state adoption managers better 
inform adoptive parents who asked them what documentation to provide 
to IRS. 

Because of this, according to officials from adoption advocacy groups 
and state adoption agencies, key information about the credit did not 
reach some taxpayers and stakeholders, especially concerning the 
requirements for certification of children with special needs. As a 
result, according to state adoption officials and adoption 
organization representatives who received calls from taxpayers, IRS 
sent notices to many adoptive families that their returns would be 
subject to audit and their refunds delayed. When adoption 
organizations contacted IRS, the agency acknowledged a problem with 
its communications and the clarity of its guidance and took some 
corrective steps, including placing additional information about the 
adoption credit and special needs documentation on its website. IRS 
plans to take additional steps, including revising the adoption credit 
claim form (Form 8839) and related instructions for the 2012 filing 
season. However, IRS has not indicated that it plans to target future 
communications specifically to state and local adoption officials. 

In addition, IRS did not adequately inform its tax examiners regarding 
certain aspects of the adoption tax credit. In particular, IRS did not 
specify in its examiner training materials what documentation it 
required and would accept to verify that adopted children had special 
needs status. While, in March 2011, IRS provided examiners with some 
examples of state adoption assistance agreements, which certify 
special needs status, it did not include any such examples in its 
training materials, even after the materials were revised in June. 
According to the state adoption officials with whom we spoke, the 
inadequate preparation of examiners led to difficulties getting IRS to 
accept adoption assistance agreements as proof of special needs 
status. For example, in response to audits and in order to get IRS to 
accept documentation, adoption assistance representatives from 
Wisconsin had to prepare a letter certifying special needs status and 
provide it to the families that were waiting on refunds. In June 2011, 
IRS revised its training materials and the Internal Revenue Manual to 
indicate that a state agreement to provide adoption assistance under 
Title IV-E of the Social Security Act was sufficient proof of special 
needs status, but did not include examples of adoption assistance 
agreements in the revised materials. IRS left the question of whether 
certification was sufficient in the absence of such an agreement up to 
the examiner's judgment. 

According to adoption advocacy organization officials, problems 
persist even after the steps IRS took, with some examiners still not 
recognizing assistance agreements from some states as proof of special 
needs eligibility. Because adoption assistance agreements vary from 
state to state and, in some states, adoption assistance agreements are 
executed at the county level, adoption advocacy representatives 
acknowledged that IRS examiners faced challenges in identifying what 
documentation would be acceptable as proof of special needs status in 
each state. IRS took some steps to clarify what constituted sufficient 
documentation throughout the filing season. However, more could be 
done to clarify for taxpayers or its examiners what would be 
acceptable documentation, such as providing copies of acceptable 
adoption assistance agreements for each state in the revised training 
materials. Providing copies of state adoption assistance agreements 
would likely be relatively low cost, particularly since 
representatives from an adoption organization told us that they had 
provided IRS with agreements from about 40 states. Because of its role 
in overseeing state adoption agencies, HHS may also be able to aid IRS 
in reaching out to state adoption agencies. 

Further, if IRS were to provide examiners with examples of adoption 
assistance agreements for each state, it could also post such 
information on its website to help taxpayers and paid tax preparers 
understand what constitutes acceptable documentation. The incremental 
cost of providing such information would likely be negligible. 

For the 2011 filing season, IRS screeners automatically directed all 
returns on which taxpayers claimed the adoption tax credit and where 
documentation was either missing or of uncertain validity to 
correspondence audit (audits by mail). A senior IRS official 
acknowledged that this process resulted in a large number of adoption 
credit-related correspondence audits and diverted IRS resources from 
other more productive audits. 

As of August 6, 2011, IRS had sent 68 percent of almost 100,000 
returns it had processed on which taxpayers claimed adoption credits 
to correspondence audit. Of those returns sent to audit, 83 percent 
were sent because of missing documentation or documentation IRS could 
not determine to be valid. IRS reported that it ended up disallowing 
all or a portion of the credit for only about 6,000 (17 percent) of 
the approximately 35,000 returns on which audits have been completed 
and assessed $17.7 million in additional tax. This means that for 83 
percent of adoption tax credit returns audited thus far, there was no 
change in the tax owed or refund due. Reducing the number of adoption 
tax credit audits would allow IRS to do more correspondence audits of 
other returns where the chance of assessing additional tax would be 
greater. To this end, all correspondence audits conducted in 2010 
resulted in additional tax being assessed 86 percent of the time, 
compared to 17 percent for the adoption credit in 2011. Further, IRS 
officials also told us that they had not found any fraudulent adoption 
tax credit claims, and there had been no referrals of adoption tax 
credit claims to its Criminal Investigation unit.[Footnote 10] 

Through September 10, 2011, IRS used a disproportionate share of its 
audit resources on the adoption credit. IRS reported spending 32,000 
staff days on adoption tax credit audits during the 2011 filing 
season. This represents about 3.5 percent of all staff days expended 
on initial review and correspondence audits. By comparison, the almost 
100,000 returns filed on which taxpayers claimed the adoption tax 
credit as of August 20, 2011, represent less than one-tenth of 1 
percent of all individual returns filed up to that point. 

According to IRS officials, data for audits completed through 
September 2011 show that an adoption credit correspondence audit 
takes, on average, 74 calendar days. This delays refunds, which, 
according to adoption agency officials, can create difficulties for 
families expecting to cover adoption costs with the refund. 

IRS Can Reduce the Number of Audits in 2012: 

According to IRS officials, there are several options, each with 
advantages and disadvantages, for how returns on which adoption 
credits are claimed could be handled in the 2012 filing season. These 
include alternatives that could reduce costs and refund delays for 
claims submitted without any documentation--41 percent of claims 
processed as of August 2011--by either employing MEA or by sending a 
notice without an audit.[Footnote 11] 

* If IRS retains its 2011 strategy, it would risk again sending a 
relatively large proportion of adoption credit claims to audit that 
generate relatively low dollar amounts of assessed taxes. Doing so 
would likely ensure that all claims are properly documented, but would 
divert IRS resources from other priorities and continue to delay 
refunds to taxpayers. 

* Alternatively, IRS could seek to obtain MEA from Congress permitting 
IRS to disallow the adoption tax credit without audit if a taxpayer 
did not supply any documentation, similar to authority granted earlier 
to IRS for returns on which taxpayers claimed the FTHBC. TIGTA 
suggested to IRS in October 2010 that it seek MEA for the adoption tax 
credit, and IRS and Treasury Department officials considered 
requesting such authority prior to the 2011 filing season. However, 
IRS and Treasury officials determined that current compliance tools 
would be sufficient. As a result, they did not request the additional 
authority. 

* Finally, IRS could institute a procedure by which, immediately 
following initial screening of the return, it would send a letter to 
taxpayers who did not provide any documentation, notifying them of 
what documentation is needed.[Footnote 12] In this case, IRS would not 
disallow the credit, but would instruct the taxpayer to respond to the 
letter within 20 days while IRS holds the return until the taxpayer 
responds. If the taxpayer is able to produce adequate documentation in 
response to the letter, the IRS examiner initially screening the 
return could approve the return for processing without further audit 
and taxpayers would receive refunds faster than they would if their 
returns were audited.[Footnote 13] However, current procedure 
specifies that if the taxpayer is unable to produce the requested 
documentation, the return would be sent for audit so that IRS can 
resolve the issue. Thus, if a taxpayer did not send in documentation, 
his or her return would also be sent to audit, possibly creating a 
longer delay than with IRS's current strategy, since there would be 
additional time spent while IRS waited for the taxpayer to send in 
documentation. 

IRS has not yet determined whether sending a letter upon initial 
screening would lead to a significant number of taxpayers submitting 
documentation after receiving the letter, thus reducing processing 
time and the number of audits. IRS officials told us that data from 
the 2011 filing season on the number of claimants who submitted 
documentation while undergoing a correspondence audit should help 
determine whether sending an initial letter after screening the return 
would be more effective. 

Table 1 summarizes the options and the potential advantages and 
disadvantages of each. 

Table 1: IRS Options for the 2012 Filing Season: 

Option: Retain 2011 strategy (review each return; 
do correspondence audit for all returns lacking proper documentation); 
Potential advantages: Ensures that all claims are properly documented; 
reduces potential for fraudulent claims and improper payments when 
compared to not conducting such audits; 
Potential disadvantages: Requires substantial expenditure of time and 
resources for limited number of disallowed claims; 
causes substantial delays for taxpayers in obtaining refunds. 

Option: Obtain and use MEA to disallow claims without any 
documentation; 
Potential advantages: Potentially limits amount of resources expended 
on audits; 
Potential disadvantages: Requires legislation; 
would require taxpayers to initiate action to obtain refunds in cases 
for which MEA was used and could delay refunds to those taxpayers. 

Option: Send a letter to taxpayer immediately upon receipt of the tax 
return, with correspondence requesting documentation; 
Potential advantages: If taxpayers supply requested documentation, 
limits amount of resources expended on audits; 
allows more taxpayers to obtain refunds more quickly; 
Potential disadvantages: If taxpayers do not supply the requested 
documentation, may delay refunds while returns are audited. 

Source: GAO. 

[End of table] 

Conclusions: 

The adoption tax credit provides a significant source of financial 
assistance to adoptive families. In part because of the amount of 
money at stake and potential for improper payments, IRS developed a 
strategy for reviewing claims and administering the credit and devoted 
significant resources to ensuring compliance. However, in implementing 
this strategy IRS missed opportunities to clarify important 
information about what documentation it deemed acceptable, increasing 
the burden on taxpayers legitimately seeking the credit. Confusion 
about the documentation combined with the process used to send returns 
for correspondence audits has resulted in delaying refunds to 
taxpayers and the use of IRS resources that could likely be better 
spent elsewhere. In reviewing its strategy for the 2012 filing season, 
IRS has an opportunity to reduce the time and resources spent on 
correspondence audits of adoption tax credit claims as well as the 
number and length of refund delays while still maintaining a robust 
enforcement strategy. 

Recommendations for Executive Action: 

For the 2012 filing season, we recommend that the Commissioner of 
Internal Revenue 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; 

* 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; 

* place the agreements on its website to help taxpayers better 
understand what constitutes acceptable documentation; and: 

* 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 Comments and Our Evaluation: 

We provided a draft of this report to the Commissioner of Internal 
Revenue. In written comments on a draft of this report (which are 
reprinted in app. II) the IRS Deputy Commissioner for Services & 
Enforcement agreed with our recommendations to extend outreach to 
state adoption managers and to determine whether requesting 
documentation before initiating audits would reduce the number of 
audits without significantly delaying refunds. 

However, although he agreed that reviewers and examiners should be 
provided examples of adoption assistance agreements, he indicated that 
IRS believes current examples of state adoption assistance agreements 
available to examiners on an internal website are sufficient to permit 
them to accurately evaluate adoption records. As we stated in our 
report, we believe making additional examples of state adoption 
assistance agreements available to examiners would impose minimal 
incremental costs. Providing additional examples would give examiners 
greater certainty that taxpayers submitted the correct documentation 
on a state-by-state basis. Doing so would also give IRS's examiners a 
more comprehensive list of acceptable documentation. In developing a 
more comprehensive set of examples for examiners, IRS could also list 
the states where documentation originates from the county or local 
level without collecting documentation from each jurisdiction. 

IRS also expressed concern that posting the agreements on IRS's 
external website might enable unscrupulous individuals to submit 
fraudulent documentation in support of a false claim. We understand 
this possibility; however, any claim for a tax credit must also be 
accompanied by proof that an adoption has taken place or is in 
progress, which would not be available on the website. Given these 
additional documentation requirements already in place, we believe 
that the benefits of making state assistance agreements available to 
adoptive parents on the IRS website outweigh the risks. 

As agreed with your offices, unless you publicly announce the contents 
of this report earlier, we plan no further distribution until 30 days 
from the report date. At that time, we will send copies to the 
Chairmen and Ranking Members of other Senate and House committees and 
subcommittees that have appropriation, authorization, and oversight 
responsibilities for IRS. We will also send copies to the Commissioner 
of Internal Revenue, the Secretary of the Treasury, the Chairman of 
the IRS Oversight Board, and the Director of the Office of Management 
and Budget. In addition, the report will be available at no charge on 
the GAO website at [hyperlink, http://www.gao.gov]. 

If you or your staff have any questions about this report, please 
contact me at (202) 512-9110 or whitej@gao.gov. Contact points for our 
Offices of Congressional Relations and Public Affairs may be found on 
the last page of this report. GAO staff who made key contributions to 
this report are listed in appendix III. 

Signed by: 

James R. White: 
Director, Tax Issues Strategic Issues: 

[End of section] 

Appendix I: Adoption Tax Credit Provisions, 1996 to the Present: 

As shown in table 2, since 1996, an adoption credit has existed. The 
credit has been expanded several times since 1996 and was made 
refundable for tax years 2010 and 2011. However, for tax year 2012 the 
credit is nonrefundable with a reduced maximum and reverts to the 1996 
law (nonrefundable maximum of $6,000 for special needs only) for tax 
year 2013 and thereafter. 

Table 2: Adoption Tax Credit Provisions, 1996 to the Present: 

Year: 1996; 
Legislation: Small Business and Job Protection Act (Pub. L. No. 104-
188); 
Amount of credit: Nonrefundable tax credit: $6,000 for special needs 
adoptions; $5,000 for all other adoptions; 
Notes on provisions: Phaseout begins at $75,000 annual income, phased 
out totally at $115,000; Allowable 5-year carryover; Income exclusion 
for employee support; Exclusion and non-special needs credit expire in 
2001. 

Year: 2001; 
Legislation: Economic Growth and Tax Relief Reconciliation Act (Pub. 
L. No. 107-16); 
Amount of credit: Nonrefundable tax credit for all adoptions; maximum 
set at $10,000 and automatically increased annually based on change in 
the Consumer Price Index (CPI); 
Notes on provisions: Initial phaseout income level set at $150,000 per 
year; phaseout limits subject to CPI-based annual increase; Provisions 
set to sunset after tax year 2010. 

Year: 2010; 
Legislation: Patient Protection and Affordable Care Act (Pub. L. No. 
111-148); 
Amount of credit: Refundable tax credit for all adoptions; $13,170 for 
2010, amount adjusted by CPI for 2011; 
Notes on provisions: Made limits on income exclusion the same as those 
for the credit in tax years 2010 and 2011; Postponed "sunset" of 2001 
law and reversion to 1996 law until tax year 2012. 

Year: 2010; 
Legislation: Tax Relief, Unemployment Insurance Reauthorization, and 
Job Creation Act of 2010 (Pub. L. No. 111-312); 
Amount of credit: Nonrefundable maximum $10,000, adjusted by CPI from 
2002 through 2012; 
Notes on provisions: Established 2001 adoption credit and employer 
assistance income exclusion for tax year 2012. 

Source: GAO. 

[End of table] 

[End of section] 

Appendix II: Comments from the Internal Revenue Service: 

Department Of The Treasury: 
Deputy Commissioner: 
Internal Revenue Service: 
Washington, D.C. 20224: 

October 18, 2011: 

Mr. James R. White: 
Director, Tax Issues: 
U.S. Government Accountability Office: 
441 G Street, N.W. 
Washington, DC 20548: 

Dear Mr. White: 

I have reviewed your draft report entitled Adoption Tax Credit: IRS 
Can Reduce Audits and Refund Delays. As your report notes, the 
Affordable Care Act changed the credit from a $10,000 nonrefundable 
credit to a $13,160 refundable credit for Tax Years 2010 and 2011. The 
value of the Adoption Credit required a comprehensive outreach and 
subsequent compliance strategy to administer the many unique 
situations for which the credit is available. The IRS implemented an 
approach that balanced the need for legitimate credits to be paid in a 
timely manner while taking steps to ensure that claims were proper. 

Our outreach strategy included collaborating with external 
stakeholders, extensive training for our tax examiners, and updating 
key publications and forms. The IRS collaborated with various state 
agencies to identify third party data that could be used to verify 
legitimate domestic and special need claims. Our communication plan 
educated taxpayers, preparers, and adoption agencies about new 
Adoption Credit requirements and provided necessary guidance. 
Additionally, our outreach efforts included updating forms and 
publications, posting information on our internal and external 
websites, conducting public service announcements, communicating with 
professional preparer communities, and collaborating with software 
developers. 

The compliance strategy included new data-driven examination filters 
based on research of recent return filings. In addition to our use of 
examination filters, the IRS required taxpayers to submit adoption 
documentation with their returns to mitigate the risk of fraud 
potential associated with the dollar amount of the credit. 

A large number of the Adoption Credit claims did not include the 
required documentation. In response, we issued targeted communications 
to remind tax preparers and taxpayers of the requirement. We also 
worked with tax preparation software developers to improve the 
guidance provided by their products, and we leveraged our 
relationships with large tax preparation firms to communicate the 
documentation issue to their preparers. 

We took steps to minimize burden on taxpayers and to avoid undue 
delays in issuing refunds; however, we also balanced those goals with 
our responsibility to protect public funds. In the coming weeks, we 
will examine our implementation strategy for the 2010 tax year to 
determine what improvements we can make for future years, and to 
cultivate service-wide best practices. 

Responses to your specific recommendations are enclosed. If you have 
any questions, please contact Robin L. Canady, Director, Strategy and 
Finance, Wage and Investment Division, at (404) 338-8801. 

Sincerely, 

Signed by: 

Steven T. Miller: 
Deputy Commissioner for Services & Enforcement: 

Enclosure: 

[End of letter] 

Enclosure: 

For the 2012 filing season, we recommend that the Commissioner of 
Internal Revenue instruct appropriate officials to: 

Recommendation 1: 

Ensure that the communications effort specifically includes state and 
local adoption officials, and clarifies acceptable documentation for 
the certification of special needs adoptees. 

Comment: 
We agree with this recommendation. The IRS plans to continue adoption 
credit outreach and education efforts. Our adoption credit 
communication strategy includes targeted outreach to state adoption 
officials and adoption organization representatives. It will highlight 
adoption documentation requirements and include specific messages for 
documentation of special needs status. 

Recommendation 2: 

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. 

Comment: 

We agree that reviewers and examiners should be provided examples of 
adoption assistance agreements and the IRS has done so. As we 
implemented the Adoption Credit examination strategy, we recognized 
the need to have comprehensive adoption credit training, revisions to 
the Internal Revenue Manual, and information for the telephone 
assistors. Examiners and reviewers were trained on critical elements, 
such as tax law and document requirements, including special needs 
documentation. The IRS placed approximately 24 examples of state 
adoption agreements on an internal website for use by the examiners 
and reviewers. This website is continuously updated with new 
information and will remain accessible to our examiners and reviewers. 
We will continue to determine if additional examples should be added, 
but at this time believe the current examples of state adoption 
agreements provided to the examiners and reviewers are sufficient to 
permit them to accurately evaluate adoption records that are provided 
with tax returns in support of adoption credit claims. Due to the 
delegation of adoption authority by some states to the county level, 
and a lack of uniformity among county and state entities, it may not 
be feasible to provide examples of all possible adoption assistance 
agreements that may be encountered. 

Recommendation 3: 

Place the agreements on its website to help taxpayers better 
understand what constitutes acceptable documentation. 

Comment: 

We agree that it is important for taxpayers to understand what is 
acceptable documentation. While posting examples of acceptable 
documentation could be helpful to taxpayers, we have significant 
concerns that doing so would also assist unscrupulous individuals use 
that information to perfect fictitious documents that would be used in 
making fraudulent claims for the adoption credit. We will continue to 
ensure that our outreach efforts are effective on this point. 

Recommendation 4: 

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. 

Comment: 

We agree with this recommendation. The IRS will consider whether 
improvements should be made to the compliance strategy implemented for 
the 2011 filing season. The IRS will consider whether requesting 
documentation prior to an audit will be beneficial or will have 
unintended adverse consequences on return processing that could 
significantly delay refunds to taxpayers. 

[End of section] 

Appendix III: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

James R. White, (202) 512-9110 or whitej@gao.gov: 

Staff Acknowledgments: 

In addition to the contact named above, Joanna Stamatiades, Assistant 
Director; Steven J. Berke; Abbie David; David Fox; Tom Gilbert; Inna 
Livits; Kirsten Lauber; and Sabrina Streagle made key contributions to 
this report. 

[End of section] 

Footnotes: 

[1] The tax year is the year in which the tax liability is incurred 
and the filing season year is the year in which the taxpayer files the 
tax return (usually the year after the tax year). 

[2] Pub. L. No. 104-188, title I,  1807(a). 

[3] Taxpayers claim the adoption credit using IRS Form 8839, Qualified 
Adoption Expenses. 

[4] Pub. L. No. 111-148  10909. 

[5] The Economic Growth and Tax Reconciliation Act of 2001, Pub. L. 
No. 107-16, raised the limit of the original credit to $10,000 and 
does not apply to taxable years beginning after December 31, 2012. 

[6] Although Congress enacted the credit in 1996, available data on 
credit claims only goes back to 1998. 

[7] GAO, Financial Audit: IRS's Fiscal Years 2010 and 2009 Financial 
Statements, [hyperlink, http://www.gao.gov/products/GAO-11-142] 
(Washington, D.C.: Nov. 10, 2010); Improper Payments: Progress Made 
but Challenges Remain in Estimating and Reducing Improper Payments, 
[hyperlink, http://www.gao.gov/products/GAO-09-628T] (Washington, 
D.C.: Apr. 22, 2009); and First-Time Homebuyer Tax Credit: Taxpayers' 
Use of the Credit and Implementation and Compliance Challenges, 
[hyperlink, http://www.gao.gov/products/GAO-10-166T] (Washington, 
D.C.: Oct. 22, 2009). 

[8] GAO, Recovery Act: IRS Quickly Implemented Tax Provisions, but 
Reporting and Enforcement Improvements Are Needed, [hyperlink, 
http://www.gao.gov/products/GAO-10-349] (Washington, D.C.: Feb. 10, 
2010), and 2011 Tax Filing: IRS Dealt with Challenges to Date but 
Needs Additional Authority to Verify Compliance, [hyperlink, 
http://www.gao.gov/products/GAO-11-481] (Washington, D.C.: Mar. 29, 
2011). 

[9] MEA is statutory authority granted to IRS by Congress to correct 
calculation errors and other obvious instances of noncompliance, such 
as claims above income and credit limits, and assess additional tax 
based on such errors without having to issue a statutory notice of 
deficiency. 

[10] A claim may be paid improperly on the basis of a claim made 
incorrectly or without proper documentation but in good faith; a 
fraudulent claim is made with intentional falsification. 

[11] Of the remaining processed returns, 41 percent had valid 
documentation and 17 percent had documentation that IRS judged to be 
invalid. 

[12] This is IRS Letter 0012C, which IRS refers to as a 12C letter. 

[13] The 12C letter instructs the taxpayer to respond within 20 days. 

[End of section] 

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