John Koskinen said refundable tax credits can be fraud magnets. (Photo: Senate Finance)

Officials at the Internal Revenue Service believe that fraud is much more common in the Earned Income Tax Credit program than in the Affordable Care Act advance premium tax credit program.

John Koskinen, the IRS commissioner, talked about how the structure of a tax credit program can affect the fraud rate Thursday, at a hearing in Washington organized by the Senate Finance Committee.

The committee posted a video recording and a written version of Koskinen’s testimony on the web.

— (Related on ThinkAdvisor: Trump backs health tax credits that have split Republicans)

Under the rules of the ACA advance premium tax credit program, “the money doesn’t go to the taxpayer,” Koskinen said. “The money goes to the insurance company.”

Under the rules of the EITC program, low-income and moderate-income families routinely get cash back from the IRS after they file their federal income taxes, Koskinen said. The tax credit is refundable, meaning taxpayers who qualify for tax credits bigger than their tax payment obligations can get cash back from the government.

Any time taxpayers can qualify for tax credits bigger than their tax obligations, and get the refund cash directly, without the cash being segregated, “it’s a magnet,” Koskinen said. “A target for identity thieves. A target for criminals. A target for preparers who are fraudulent, and hang out signs saying, ‘Come with me; I’ll get you a big refund.’”

Some critics of the ACA have wondered if fraud would be a big problem for the ACA premium tax credit program.

At this point, because the ACA tax credit refund cash goes to the health insurers, not to the taxpayers, ACA premium tax credit fraud has not been as much of a problem as EITC fraud, Koskinen said.

The IRS believes program rules that keep tax credit refund money from simply merging with the rest of a taxpayer’s finances can help reduce fraud risk, Koskinen said.

Koskinen said the IRS is interested in the mechanics of tax credit programs and is neutral on the ACA itself.

“You can blow it up, if you like, and that’s fine with us,” Koskinen joked.

Tax Credits

The EITC program provides cash for low-income and moderate-income working families.

The amount of cash families get depends on their income and the number of children they have. If the value of the credit is bigger than the amount of federal income taxes a family would pay, the family gets cash back from the IRS. The family can spend the money how it wants.

The ACA advance premium tax credit program helps low- and moderate-income families cut the amount of cash they pay out of pocket for health coverage purchased through the ACA public health insurance plan exchange system.

— (Related on ThinkAdvisor: ACA definitions: Enrollment period basics)

A moderate-income family that wanted ACA exchange coverage and premium subsidy help for all of 2017, for example, had to apply for the coverage by December 2016. The family had to estimate what its income for 2017 would be when it applied for the coverage. The exchange system calculated what the family’s tax credit subsidy level should be based on the family’s 2017 income projection. The government is now sending tax credit subsidy cash to the health insurer that’s covering the family.

In early 2018, when the moderate-income family files its federal income tax return for 2017, the family is supposed to go through a reconciliation process, to see whether it received too much premium tax credit help or too little. If the family received too much help, the IRS might deduct part or all of that amount from the family’s tax refund for 2017. If the family received too little help, it may then get extra cash added to its refund.

Sen. Bill Cassidy, R-La., a Senate Finance Committee member who has worked with Sen. Susan Collins, R-Maine, to develop a proposal for replacing much of the ACA, has included a refundable premium tax credit provision in that proposal. Many other major Republican ACA-change proposals, including the last public draft of H.R. 1628, the American Health Care Act bill, include refundable premium tax credit provisions.

IRS’ thinking about tax credit program structure could affect efforts to develop federal tax incentive programs outside of the health sector. When Kent Conrad  of the Bipartisan Policy Center testified at a Senate Banking, Housing and Urban Affairs Committee subcommittee hearing on retirement security Wednesday, for example, one of his recommendations was that the country create a refundable retirement savings tax credit.

— Read Conservatives pan GOP Obamacare plan as ‘welfare’ on ThinkAdvisor.