If you file a tax return and claim a refund, but it turns out that you should not have claimed a refund (or if you claimed an excessive refund), you could be liable for payment of penalties. Similarly, if you made an erroneous or excessive claim for a tax credit, the IRS has authority to assess penalties. The penalty could be as much as 20 percent of the erroneous refund or credit claim, and it may be assessed without regard to the taxpayer’s good intentions. Innocent mistakes are equally subject to penalty.
The IRS hasn’t been very diligent in enforcing this penalty in the past several years, but the Treasury Inspector General for Tax Administration (TIGTA) hopes that will change. In a recent audit report, TIGTA discovered that the IRS had initially misinterpreted the law allowing assessment of penalties, and then even after modifying their official interpretation, still failed to adequately enforce it.
It seems hard to believe that there would be a tax penalty statute on the books that the IRS wasn’t interested in enforcing, but it’s true. Between May 2007 and May 2012, the IRS assessed only 84 erroneous refund penalties totaling $19 million. That’s only about 17 per year, although the average assessment was upwards of a quarter million each. It looks like the IRS had been targeting only the most egregious high-dollar cases.
In May 2012 the IRS admitted the tax law interpretation error and published an updated memorandum, but still has not put into place processes and procedures to guide front-line IRS personnel who make the day-to-day decisions of whether or not to pull the trigger on penalties. Consequently, between June 2012 and May 2013, the IRS had allowed over 700,000 erroneous tax credits to slide by un-penalized to the tune of $1.5 billion in lost revenue. And it is not just about lost revenue; it is about training the American taxpayer to be careful with the claims made on tax returns, because errors and false claims impose a big burden on the IRS in terms of both time and money.