Suitability of Tax System for Delivering Subsidies to Schooling Costs

In 2011, the Treasury Inspector General for Tax Administration (TIGTA) released a report highly critical of the administration of the AOTC (Treasury Inspector General for Tax Administration 2011). TIGTA inspected the income tax returns that claimed in AOTC in 2009, the first year of the credit, and found ambiguities in two million returns qualifying for $3 billion in credits. Most of these flagged returns lacked a Form 1098-T by the IRS that support students' attendance at an eligible college. The same colleges that qualify for federal financial aid qualify for the tax credits, so this reflects a failure of coordination between the US Department of Education (hereinafter, ED), which has a constantly updated list of eligible institutions, and the IRS which failed to obtain it. The report pointedly referred IRS to a publicly available dataset of institutions in the Integrated Postsecondary Education Data System.

The report also noted that institutions inconsistently fill out the 1098-T, the information return that is used to report eligible postsecondary expenses to IRS. The intent of this form is to gather information about a student's costs net of any scholarship aid. The TIGTA concluded that some colleges fail to net out scholarships. TIGTA also identified 350,000 cases in which a household received a credit even though the information on the 1098-T indicated they did not fulfill at least one of the eligibility criteria (at least half-time, undergraduate). The report emphasized that reducing fraud and error in the education credits will require better gathering of information from taxpayers and postsecondary institutions.

IRS defended its performance in its response in the TIGTA report, indicating that fraud was not nearly as rampant as the report implied (Treasury Inspector General for Tax Administration 2011). In particular, IRS noted that while the TIGTA report correctly noted that millions of AOTC recipients had not had their postsecondary institutions confirmed, this was due not to fraudulent filings but to weaknesses in the IRS's databases of eligible institutions, which they pledged to improve.

In response to the TIGTA report, legislation was introduced to the House to tighten administration of the AOTC. The proposed legislation would require that taxpayers list the employer identification number of a student's postsecondary institution. In theory, this should be present on the 1098-T, but apparently some institutions listed incorrectly.

None of these administrative challenges are insurmountable. The TIGTA is holding IRS to a degree of oversight that ED has maintained over colleges for decades. However, while ED has all of the necessary lists and procedures and lines of communication in place, IRS is relatively new to the student aid game. Until the agency gets its procedures into place, the opportunities for error and fraud are widened. The TIGTA report warns, however, that improving these procedures may create additional paperwork burdens for families and colleges.

With the rapid growth of the tax credits, an increasing number of students now complete paperwork for both the IRS and the US Department of Education in order to obtain college funding. And there is more paperwork on the horizon for families and colleges, with the Treasury Inspector General putting pressure on the IRS to obtain more documentation from applicants and colleges regarding their eligibility for the tax credits. If carried through, these steps will largely duplicate the work that ED already does in administering the traditional aid programs and multiply paperwork burdens on households and colleges.

ED and IRS bring complementary strengths to the administration of aid for college. ED has long experience in delivering aid to students and communicating with colleges. IRS has a well-developed capacity for gathering and verifying income data from households. Conversely, IRS has little experience with verifying student enrollment and delivering aid when it is needed. And while ED has long experience in gathering income data from applicants, it does so by imposing substantial paperwork burdens upon households and colleges. Just one example: colleges are statutorily required to “verify” a minimum of 30% of their aid applications each year, an auditing process that requires applicants to submit extra supporting documentation, including copies of tax returns. Some colleges audit 100% of their aid applications. Were tax data alone used to calculate aid eligibility, the data underlying all applications would automatically be verified, since it would come from the IRS rather than the applicant.

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