IRS Audit News: Expect Increased Tax Audits Due to Taxpayer Abuse of First Time Homebuyer Credit

The IRS is set to audit many more returns in 2009 and 2010 due to abuses by taxpayers of the first time home buyer tax credit. The first-time homebuyer tax credit is a tax break of up to $8,000 for qualified home sales before December 1, 2009.

Not everyone qualifies for this credit and I’ve also blogged about common misconceptions about the first time homebuyer tax credit.  Knowing the rules and filing an accurate tax return is important if you want to avoid tax audits and stay out of IRS trouble!

While the senate is moving to extend and expand eligibility for the homebuyer tax credit to encourage more Americans to enter the real estate market, the Internal Revenue Service is facing significant challenges in verifying eligibility for program.

New legislation will help the IRS prevent abuse of the credit and ensure that the credit is administered accurately to issue a timely refund of the credit and to protect financial resources.

One common abuse is taxpayers putting home titles in their children’s names, however the new legislation would require taxpayers to be age 18 or older to claim the credit as well as proof that the new home was acquired their primary residence.

CCH (http://tax.cchgroup.com) reports:

Ways & Means Subcommittee Hearing on Abuses in First-Time Homebuyer Tax Credit Results in Proposed Legislation, IRS Promise of Increased Exams

In response to a Treasury Inspector General for Tax Administration (TIGTA) report on IRS deficiencies in the administration of the first-time homebuyer credit (FTHBC), House Ways and Means Oversight Subcommittee Chairman John Lewis, D-Ga., held a hearing on credit abuses on October 22, that ended with the introduction of a bill to remedy the problem. The TIGTA report, “The Internal Revenue Service Faces Significant Challenges in Verifying Eligibility for the First-Time Homebuyer Credit” (Reference Number: 2009-41-144), was made available to the subcommittee on September 29 and was released to the public on October 22, in conjunction with the hearing.

The Treasury Inspector General for Tax Administration J. Russell George, Deputy IRS Commissioner for Services and Enforcement Linda Stiff, and Director of Strategic Issues for the U.S. Government Accountability Office James White all testified during the hearing on the many issues plaguing the popular tax benefit.

TIGTA Audit Report

George began his testimony by describing the results of TIGTA’s recently released audit report. The report acknowledges that the IRS established computer programs to control abuses of the FTHBC, including rejection of a return where the taxpayer had not filed a Form 5405, First-Time Homebuyer Credit. However, TIGTA discovered many instances of noncompliance and potential fraud within sampled areas.

Among its findings, TIGTA found that the IRS did not request any further documentation in addition to a taxpayer’s income tax return to verify whether a claimant was actually eligible for the credit. TIGTA found approximately 74,000 instances of prohibited prior home ownership among taxpayers claiming the credit. The audit also uncovered 580 taxpayers under age 18 claiming the credit, with the youngest at age four. While possibly legitimate, this caused suspicion among TIGTA’s auditors that parents were using tax reporting on behalf of their children to avoid the credit’s adjusted gross income limitations.

George noted that TIGTA is currently working toward releasing an audit report on related-party transactions and the FTHBC in the near future.

TIGTA also found instances of taxpayers claiming the lower $7,500 amount of the FTHBC for a home purchased in 2009 and legally subject to the $8,000 credit. The IRS is not contacting these taxpayers; instead, it is assuming that these taxpayers are aware of the additional $500 available and that they would amend their returns if necessary. Additionally, most of these taxpayers, TIGTA discovered, were not correctly coded in the IRS’s computer systems to indicate that they actually purchased the home in 2009. As a result, these taxpayers could be listed within the IRS’s system as having to repay the credit under the 2008 rules, when they did not actually have to do so under the 2009 version of the FTHBC.

Further, George described how legislation is needed to give the IRS “math error authority” in disallowing faulty claims for the FTHBC. As explained by White, Congress may grant the IRS authority to identify calculation errors and check for obvious noncompliance within specified areas of an income tax return. This provides an administrative benefit to the IRS because it can catch the filing errors during its tax return processing and is not required to wait until it brings an examination to address the issue.

Stiff reported that the IRS has not required submission of additional documents along with taxpayers’ income tax returns claiming the FTHBC specifically because the IRS lacks math error authority in this area. Without math error authority, she explained, such a submission would not have made a difference in the Service’s procedures. The IRS would have simply audited taxpayers with suspicious claims for the FTHBC and requested the information from additional documents at that time.

IRS Response

Despite several auditor comments raising several concerns, the TIGTA report stated that IRS management agreed to TIGTA’s recommendations to fix the problems raised by the report in connection with the administration of the FTHBC. Stiff also acknowledged in her testimony that a minimum-age requirement for the credit, math error authority, and third-party reporting requirements could all assist the IRS in more effectively administrating the FTHBC. However, she reminded the subcommittee that there is always potential for both fraud and errors whenever a refundable tax credit is enacted and that the IRS had, in fact, modeled its efforts to prevent abuses of the FTHBC on its other compliance programs. She also reported that the IRS is continuing to undertake compliance checks to identify and select for audit those FTHBC claims with the highest risk of noncompliance or possible fraudulent activity. According to Stiff, the IRS has identified “over 160 potential schemes resulting in scores of criminal investigations.”

Stiff also pointed out that congressional approval of the IRS’s fiscal year 2010 budget would go a long way toward improving administration of the area as well. She pointed out that the Service’s deficit in resources and administration of two different FTHBCs during the middle of the 2008 filing season played a large role in the issues presented by TIGTA.

Resulting Bill

After receiving testimony at the subcommittee meeting, Lewis introduced a responding bill. The legislation addresses specific problems raised at the hearing. It would require a taxpayer to be age 18 or older in order to claim the credit. It would also require taxpayers to provide additional information along with their income tax returns to prove they actually acquired the income for their primary residence, such as a Form HUD-1, U.S. Department of Housing and Urban Development Settlement Statement. Also, the IRS would have authority to look to prior-year returns and determine whether a taxpayer is eligible for the credit. Although no language is yet available for the proposal, sources told CCH that the bill would also grant the IRS math error authority on the issue of the FTHBC.

“This legislation will help ensure that the IRS has the tools and authority it needs to prevent abuse of this credit,” Lewis stated in a press release. “We must ensure that we are administering the credit accurately and strike a balance between issuing a timely refund of the credit and protecting federal resources.”

By Torie Cole, CCH News Staff

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4 Responses to “IRS Audit News: Expect Increased Tax Audits Due to Taxpayer Abuse of First Time Homebuyer Credit”

  1. charles parker Says:

    Is an “agreement for sale” qualified for the $8000 tax credit?

  2. TRS Says:

    Hi Charles. No -an “agreement for sale”does not qualify. Escrow must close and title MUST PASS to qualify for the tax credit

  3. Rick Says:

    How is “primary residence” defined?

    How long must the first time buyer maintain ownership of the home in order to retain the tax credit?

    Can the tax credit be carried forward to tax years subsequent to the year the home is purchased?

  4. TRS Says:

    Hi Rick, Here is some good info on the irs.gov web site: http://www.irs.gov/newsroom/article/0,,id=187935,00.html/ If you are experiencing tax problems due to the application of this credit or have another tax trouble you need to resolve, please call our offices at 866-477-7762.

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