Having recently noted that the United States Internal Revenue Service’s (IRS) processes can be ineffective in identifying tax returns claiming improper tax credits and fraudulent tax refunds, a further report from the Treasury Inspector General for Tax Administration (TIGTA) has accused the agency of misinterpreting the law and thereby limiting its ability to assess penalties.

The TIGTA conducted an audit to determine whether the IRS is properly assessing the erroneous claims for refund or credit penalty on individual tax accounts, but decided that, by incorrectly interpreting federal law, the IRS has significantly limited the number of claims on which it can assess penalties.

It noted that the Small Business and Work Opportunity Tax Act of 2007 amended the Internal Revenue Code to enhance the IRS’s ability to seek monetary penalties for the growing number of erroneous tax credit and refund claims. Under the law, taxpayers who claim excessive tax credits or refunds may be penalized up to 20 percent of the erroneous claim. It found however that the IRS has not correctly used the power to charge penalties for these erroneous claims.

The TIGTA found that, up to May 2012, the IRS had incorrectly interpreted the erroneous refund penalty law in relation to when the IRS had the authority to assess a penalty, and had, consequently, assessed only 84 erroneous refund penalties totaling USD1.9m between May 2007 and that date. In response to concerns raised from various IRS functions, the IRS Office of Chief Counsel has revised its interpretation of the law and issued an updated memorandum. The IRS should therefore be taking action in respect of erroneous tax claims in future.