IRS watchdog finds $5.6 billion in possible waste due to 'potentially erroneous' education tax credits

The IRS may have approved up to $5.6 billion worth of education tax credits that should never have been allowed, according to a new report from the Treasury Inspector General for Tax Administration.

TIGTA's report, released Tuesday, noted that a law passed in 1997 created two education tax credits, while the 2009 stimulus bill replaced one of these with the new American Opportunity Tax Credit, which will remain in effect at least through 2017.

A new report says the IRS may have improperly allowed billions of dollars in education tax credits in 2012. Photo Credit: AP

But TIGTA found several problems with these credits, and said the IRS at this point still has no sure way to make sure people are claiming these credits properly. "The IRS still does not have effective processes to identify erroneous claims for education credits," it said.

"Based on our analysis of education credits claimed and received on tax year 2012 tax returns, TIGTA estimates that more than 3.6 million taxpayers (claiming more than 3.8 million students) received more than $5.6 billion in potentially erroneous education credits ($2.5 billion on refundable credits and $3.1 billion in nonrefundable credits)," the report said.

Specifically, the report found that 2 million taxpayers got more than $3.2 billion in education credits for students without filing the proper form. That form is the 1098-T tuition statement.

More than 1.6 million taxpayers got $2.5 billion in credits for students attending ineligible educational institutions.

Additionally, more than 400,000 taxpayers got more than $650 million for kids claiming the American Opportunity Tax Credit for more than four years, something that isn't allowed under the law.

And finally, more than 400,000 taxpayers got $662 million in credits for kids in school less than full time, which also isn't allowed.

TIGTA made five recommendations to help ensure the IRS can properly track these problems, but the IRS rejected three of those ideas.

First, TIGTA said the IRS needs to use Department of Education data to help it assess whether claims for tax credits are valid, but the IRS said it's not allowed to use this data. TIGTA also said the IRS should try to verify credit claims at the time tax returns are processed, but the IRS said "processes are already in place to use some external data in addressing questionable items on tax returns at the time of processing."

TIGTA also said the IRS should automatically reject claims for the tax credit after four years, but the IRS said that make it harder for people to claim other credits that might be available.

The only recommendation the IRS agreed with was to make the 1098-T form more readily available, and to make it easier to identify claims for students who are prisoners.