The Internal Revenue Service is not using the available data to identify potentially erroneous claims for the Rehabilitation Credit, a tax incentive given to private sector developers for restoring and maintaining historic structures, according to a new report.
The report, from the Treasury Inspector General for Tax Administration, noted that the Rehabilitation Credit is jointly administered by both the IRS and the National Park Service. Qualified applicants can claim up to 20 percent of their expenditures as a credit to reduce their overall tax liability. For tax year 2013, approximately $732 million in Rehabilitation Credits was claimed on 2,168 tax returns.
The nonrefundable general business tax credits are subject to certain limitations, such as passive activity loss limitations. The National Park Service has to certify that the rehabilitation project is consistent with the historic character of the property and, where applicable, the district in which it is located. The building must be rehabilitated for commercial, industrial, agricultural, or rental residential purposes and not be used exclusively as the owner’s private residence. The credit is calculated as a percentage of qualified expenditures. The expenditures are generally taken into account for the tax year in which the rehabilitated building is placed in service.
As with other general business credits, the IRS does not determine the primary qualifications of the project on which the Rehabilitation Credit is based. Instead, the IRS relies on a certification provided by the National Park Service. The NPS assigns a number to each rehabilitation project when the certification application is submitted. However, the third-party data received from the NPS is not being used to identify potentially erroneous Rehabilitation Credit claims ahead of time.
TIGTA noted the cornerstone of the IRS’s ability to ensure compliance with many tax provisions is the ability to obtain reliable third-party data. Although the IRS receives a complete electronic copy of the NPS database twice a year, it has not established effective processes to use the data to identify potentially erroneous claims, both during tax return processing and in post-processing compliance efforts.
The report said processes are needed to ensure the required information to claim the Rehabilitation Credit is provided and is accurate on all tax forms. TIGTA reviewed 2,720 Forms 3468, Investment Credit, from tax year 2013 and identified 39 taxpayers claiming nearly $47 million in Rehabilitation Credits that did not provide either the required NPS project number or Employer Identification Number of a pass-through entity.
The IRS lacks a process to identify invalid NPS project numbers or pass-through entity EINs during processing of tax returns, according to the report. TIGTA’s review of the 2,720 tax year 2013 Forms 3468 identified 12 taxpayers claiming $154,639 in Rehabilitation Credits that provided an invalid NPS project number or pass-through entity EIN.
TIGTA recommended the IRS develop processes and procedures to use NPS data to identify potentially erroneous claims and revise its programming to identify and reject electronically filed business tax returns claiming the Rehabilitation Credit in which the required information is not provided on Form 3468 and when the information provided is invalid. TIGTA also recommended the IRS work with the Treasury Department’s Office of Tax Policy and propose existing regulations to provide clear reporting requirements for claiming the Rehabilitation Credit.
The IRS agreed with four of TIGTA’s recommendations, partially agreed with one recommendation, and disagreed with three recommendations.
“The vast majority of rehabilitation tax credit dollars are claimed by a small number of very large taxpayers,” wrote Karen Schiller, commissioner of the IRS’s Small Business/Self-Employed Division, in response to the report. “The likelihood of audit for these taxpayers is very high under our normal audit selection process.”
She noted that in tax year 2013, the IRS evaluated the compliance risk of 35 returns, which accounted for 68 percent of the total Rehabilitation Tax Credits claimed by taxpayers that year. In tax year 2012, approximately 70 percent of the Rehabilitation Tax Credit dollars claimed by a limited number of very large taxpayers were selected for examination.
The IRS agreed to work with the Treasury Department on changes to the existing regulations that would provide clearer reporting requirements for claiming the Rehabilitation Credit. However, Schiller disagreed with TIGTA’s recommendation to use NPS data during returns processing and to reject all e-filed returns that have Forms 3468 with missing or invalid EIN or NPS information.
“An EIN or NPS number on a Form 3468, in and of itself, does not verify compliance, and, conversely, the lack of a valid number does not demonstrate that a claim is erroneous,” said Schiller. “This information is used to assist in identifying NPS projects associated with rehabilitation tax credit claims.”
TIGTA found that taxpayers provided proper EIN and NPS numbers in nearly 95 percent of all Form 3468 filings, and despite missing or invalid information, the IRS was able to identify the NPS project or source of the qualified rehabilitation expenditures in more than half of the remaining forms, Schiller pointed out.
“At this time, implementing TIGTA’s recommendations would yield minimal compliance benefits while imposing unnecessary burdens on taxpayers with valid rehabilitation tax credit claims,” she wrote.